- by New Deal democrat
I don’t normally discuss movements in the stock and bond markets, but occasionally there are important paradigm shifts that can tell us a lot about the economy, and the last few months have been one of those times.
The Federal Reserve began to cut interest rates on September 18th. What is instructive is what has happened with bond yields, and the comparative moves in stock prices, since.
The 10 year Treasury bond (dark blue) made a low of 3.63% on September 16. In the below graph, I norm that value to 0, and similarly norm yields on 2 year (light blue), 1 year (gray), 6 month (gold), and 3 month (red) Treasurys, so that their trends before and after that inflection point are apparent:
Interest rates were generally trending down across the spectrum in the five months before September, as signs of economic weakness, particularly in several summer jobs reports, worried investors that the Fed had kept rates high for too long, and needed to start cutting them to boost the economy.
But what is interesting is what happened since. While the very short maturities followed the Fed rate cuts lower, from the 1 year maturity out, bond yields *rose.* This tells us that in the aggregate, bond investors believed that either the Fed’s rate cutting regimen would be short lived, and/or that inflation would increase. This is referred to in bond trader circles as a “bearish steepening.” In other words, the bond yield curve un-inverted, but did so mainly because longer term rates rose - meaning that things like mortgage rates would also increase.
Which brings us to the stock market. Below I compare yields on the 10 year Treasury to stock prices as measured by the S&P Index for the past five years:
Sometimes the two move in tandem, and sometimes they move in opposite directions. In the immediate post-pandemic aftermath, yields and prices rose together, consistent with an expanding economy. In 2022, as most investors and analysts became nervous that a recession was near (triggered in no small measure by the inversion of the bond yield curve), prices fell even as yields increased in response to Fed rate hikes. In 2023 and earlier in 2024, as fears abated and the “soft landing” scenario took hold, once again prices and yields moved in the same direction.
Now let me focus on the past ten months:
Except for the brief period between the first rate cut and the Election, where both metrics moved in sync along with economic optimism, prices and yields have moved in opposite directions again. In the period between April and September, that was because there was increasing worry that a “hard” landing was in store.
But the second period began within two days after the Presidential Election in November. At first stock prices rose on economic optimism, while bond yields fell. But stock prices peaked almost immediately, with even the December highs only being only 1.5% above their level on November 11. And bond prices have moved almost relentlessly higher, including to new 12 month highs this month. This is much less likely about future Fed behavior than about inflationary policies likely to be in store from the new Administration.
Long term trends back up this inflationary concern. Bond yields tend to move in very long cycles, equivalent to more or less one human lifespan (or “saeculum”), suggesting the old adage that as lived history is forgotten, old dangers are renewed.
Here is the history of long term bond yields from 1920 to 1980:
After slowly declining from 1920 to 1940, beginning in the 1950s bond yields increased for 30 years, as inflation slowly, and then more quickly, took root.
Now here is the same graph since 1981:
Bond yields declined for a long period, coinciding with disinflation and then even concerns about outright deflation. That period appears to have abruptly ended with the pandemic.
All the signs are that we have begun a new inflationary era in which bond yields are likely to continue to generally rise. And all the signs are that the policies of the new Administration are going to contribute to that.
