Rising bond yields and the stock market don’t mix. That was the story this week as the 10 year bond approached 5.25% sending the stock market reeling. Here is a great introductory article that explains the inter-relationships.
Source: Financial Sense Online
by Andy Sutton
First, let us also make clear the role of the Fed and financial markets in the determination of interest rates. When interest rates and the Fed are mentioned, they are referring to very short term rates, in particular the rates that banks charge each other for overnight loans. When we talk about longer-term rates, these are set by the bond market. Bonds are traded in a fashion similar to stocks. Their price and yield are inversely proportional. If the price of a bond goes down, the yield rises and vice versa. Bonds of varying maturities up to 30 years are available for purchase. The yields of these various instruments make up what is referred to as the yield curve.
Bond prices have a direct impact on mortgage rates. The Fed doesn’t control mortgage rates directly through changes in the discount or overnight rates. The Fed can act clandestinely to ‘work the yield curve’, however. Higher yield rates on bonds have a profound impact on mortgage rates. The headlines have told the story in recent weeks as mortgage rates have continued to trickle higher. Obviously, this is going to create some problems. For a while, cheap loans have fueled the housing market and through it, consumer spending in the form of equity withdrawals. As rates rise, we are going to see a constriction in these loans and we’ve already been through what the results of this will be. The ramifications could prove to be very negative for the housing market, consumer spending and the economy in general. Note that GDP in the US is at a stall rate despite massive growth in the M3 monetary aggregate. In terms of inflation, the monetary authorities don’t seem to be getting as much economic bang for their fiat bucks.