In the past 10 days alone, the 10-year Treasury yield (^TNX) has surged approximately 25 basis points, reaching a level of about 4.29%. This uptick has sparked apprehension among investors, with some fearing that further increases in bond yields could negatively affect stock performance once again.
Morgan Stanley’s chief investment officer, Mike Wilson, highlighted the significance of the current yield level in a recent note to clients, stating, “We view 4.35% on the 10-year US Treasury yield as an important technical level to watch for signs that rate sensitivity may increase for equities.”
The sentiment regarding bond yields is reflected in Bank of America’s March Global Fund Manager Survey, which indicates a shift in expectations. Only 40% of managers now anticipate lower bond yields, down from 62% in December, marking the lowest level of yield reduction expectations in the past year.
Wilson observed that large-cap stocks have displayed less sensitivity to rate movements compared to small caps. He noted, “Small caps are likely to show more rate sensitivity than large caps on a move higher in yields.”
Despite the market scaling back expectations of rate cuts by the Federal Reserve, the S&P 500 (^GSPC) has remained resilient, hovering near record highs. This resilience has been attributed to the strength in large-cap stocks, evidenced by the recent broadening of the market. Sectors like Materials (XLB) have experienced increased activity, while the Russell 2000 small-cap index (^RUT) has continued to lag.
The future trajectory of equity markets hinges significantly on the evolution of rate uncertainty. Many analysts argue that for a full broadening to occur in the stock market rally, investors will need to gain confidence in the Federal Reserve’s interest rate policies. The central bank is set to announce its next policy decision later on Wednesday.
Although no interest rate cut is expected, investors anticipate gaining insights into the Fed’s stance through its Summary of Economic Projections. Of particular interest is the “dot plot,” which outlines policymakers’ expectations for future interest rate movements. Following several reports of higher-than-expected inflation and no signs of an economic slowdown, economists have cautioned that the Fed may revise its projections for rate cuts downward.
The potential shift in the Fed’s stance is viewed as hawkish by some analysts, which could exert upward pressure on rates and the US dollar, all else being equal, according to Bank of America’s rate strategy team.
Kristy Akullian, senior investment and portfolio solutions strategist at BlackRock, suggested that while some of the anticipated impact of changes in Fed rate cut expectations may already be factored into large-cap stocks, other areas of the market, particularly small caps and highly leveraged companies, could continue to face challenges.
“Investors should remain vigilant as developments in bond yields and Fed policies unfold, as these factors are likely to influence market dynamics in the coming days,” concluded analysts.
