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Daniel Snyder
September 30, 2021
The U.S. bond market has a massive value of about $40 trillion compared to less than $20 trillion in the domestic stock market. The U.S. Treasury issues bonds with fixed coupon rates initially through auction to financial institutions like banks. From there, the bonds are offered to the secondary market. Similar to the stock market, bond values depend on the supply and demand for those bonds. Bonds with higher coupon rates generally have a higher value to them since their rate of return is higher. On Tuesday, September 28, the stock market declined dramatically with benchmark indexes S&P 500, Dow 30, Nasdaq, and Russell 2000 all down. Each index declined 2.04%, 1.63%, 2.83%, and 2.25%, respectively. These decreases came after a sudden rise in U.S. Treasury yields. The 10-year note rose to 1.54%, its highest level since June.
As a general rule of thumb, stock and bond prices are inversely related, meaning as bond prices rise, stock prices fall, and vice versa. The 10-year Treasury bond yield rising indicates good investor sentiment as it signals a decrease in demand for those treasury bonds and therefore higher demand in higher risk investments. However, that does not mean that higher yields in the bond market pushes stocks higher. Higher yields in bonds make them more attractive, as they are also considered generally safer investments than stocks. Stocks generally return at a higher rate, but also have a higher rate of volatility and more risk. On the other hand, when bond yields decrease, the higher risk-reward potential in stocks becomes more attractive as the potential reward from bonds decreases. The 10-year Treasury note yield also correlates into other interest rates, like fixed-mortgage rates or loans taken out by companies. Fixed-mortgage rates rising will in turn drive down activity in the housing market, as mortgages get more expensive. This decrease in housing activity causes the overall economy to slow down. Increases in company loan rates causes less borrowing and financing for investing activities, therefore limiting growth for those companies. Both these changes in interest rates can negatively affect the stock market, as growth in the overall economy slows down. Recently in the market, we saw a big sell off in tech stocks. Tech stocks were the main focus, due to their elevated risk and higher P/E ratios. The higher P/E ratios mean investors are paying more for $1 of the company’s future earnings, meaning there is more risk involved compared to other stocks with lower P/E ratios. In addition, dividend stocks were another focus, as people depend on those stocks for steady income. Instead, the higher Treasury bond yield can act as steady income with less risk involved.
Treasury bonds exist through the U.S. Treasury for the purpose of raising money when needed. Treasury bonds are considered to be one of the safest investments there are, with a bond rating of AA+ from Standard & Poor. They used to be AAA, but were downgraded in 2011. Since the U.S. can just keep printing money, there is not really a way that the U.S. can default on Treasury payments. The only real way they can default is if the debt ceiling is not raised when it needs to be. Once the U.S. reaches the debt ceiling, they are not able to issue new Treasury bonds, and therefore cannot raise more money. Not being able to raise money to pay off debt could eventually make them default on those loans.
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