Panic Arises Among Stock Market Investors As Treasury Yield Rises Over 3 Percent

Anxiety seems to set in among stock market investors when the 10-year Treasury yield rises over 3 percent. According to a well-known expert, this is because of the high levels of corporate debt.

In the 1970s, Treasury rates of 10% were normal. Neither the federal government nor corporations can afford these returns now. As a result, Treasury rates are the focus of the Fed’s ‘Fed Put’ and the ‘Fed Squirrel’ in the stock market, according to DataTrek Research co-founder Nicholas Colas.

Since at least the October 1987 stock market fall spurred the Alan Greenspan-led central bank to decrease interest rates, investors have spoken about a symbolic Fed put. 

As a result of the Fed’s aggressive rate-hiking intentions in response to high inflation, stocks have fallen in 2022. S&P 500 SPX, +0.31% this month flirted with bear market territory before recovering, while the more rate-sensitive Nasdaq Composite COMP, +0.40% fell into a bear market earlier this year. — a 20% drop from the previous high. 

Stocks have fallen by more than 13% for the year, while the Dow Jones Industrial Average has dropped by more than 9% and the Nasdaq is down by 22.9 percent.

According to Colas, the public debt of the United States is currently 125 percent of GDP, up from 31 percent in 1979. He added that business debt is now 49 percent of GDP, compared to 35 percent in 1979. (see chart below).

Colas noted that corporate debt-to-GDP is 40% greater than in the 1970s inflationary/high interest-rate scenario. Although equity issues to pay down debt may not be a favorite of CEOs or shareholders, it can be done if debt-service expenses get out of hand, he added that significantly greater equity values for public and bigger private firms than in the 1970s counterbalance this.

Efforts to combat inflation, on the other hand, need to take into consideration the fact that public and corporate debt has grown significantly since the 1970s, he says.

“The Fed put” has changed from stocks to Treasurys since the 1970s’ 10 percent+ Treasury and corporate rates might do more harm today than they did then, according to Colas.

Policymakers at the Federal Reserve “understand” that they must keep “structural inflation” under control and “Treasury rates” low. Lower than in the 1970s, he said.

Colas explains this by pointing out that when Treasury rates approach 3% in the fourth quarter of 2018 and currently, the U.S. equities markets grow jittery.

“Neither the federal government nor the private sector cannot handle a 3% cost of risk-free capital. As a matter of fact, “the market’s method of indicating the multitude of uncertainty if rates don’t stop at 3 percent, but rather keep climbing,” he added.”