Friday’s strong jobs report drives market sell-off
On Friday, the U.S. released a surprisingly strong jobs report. Economy added 256,000 – 90,000 jobs in December more Above consensus – the unemployment rate unexpectedly fell to 4.1%.
In response, the 10-year Treasury yield rose 8 basis points to 4.75% (the highest level in more than a year), while major stock indexes fell about -2%.
10-year interest rate rises amid economic resilience and stubborn inflation, acting as headwind for stock market gain of more than 4.4%
The 10-year yield has actually been growing fairly steadily since mid-September – up +115 basis points during that time (chart below, black line).
This upward trajectory is driven by several factors:
- Real interest rates rose as data continued to show the U.S. economy was performing better than expected while interest rates remained high
- Inflation expectations rise as inflation remains above Fed’s 2% target
- and the pricing of potential policy changes that could continue both trends.
Looking at the chart below, you’ll see that since Treasury yields’ lows in September, stock prices (blue line) have risen in tandem with Treasury yields… to a point.
Once the 10-year Treasury yield exceeded 4.4% (red line) in mid-December, further increases in Treasury yields would cause stock prices to fall.
In fact, we’ve seen this pattern continue over the past year or so (red zone). However, when Treasury yields fall below 4.4%, we see stock prices and bond yields rise together (green area).
Higher interest rates make high valuations harder to sustain
There is nothing magical about this 4.4% threshold. It’s been over the past year or so that the market has started to worry about stock valuations.
Since investors are paying for a company’s future earnings streams, interest rates are important to how they value a company. When interest rates rise, it becomes more expensive to borrow money to fund operations in order to realize future earnings. That makes higher P/E valuations harder to justify — and large-cap stocks currently have high P/E multiples.
Therefore, through stock selling, it helps to reduce the price-to-earnings ratio to a level acceptable to the market.
The question for stocks is where interest rates will go.
Some believe the 10-year rate could rise to 5% (or higher), which would hinder further gains in stocks. Of course, disappointing data (or lower inflation numbers) could push yields lower. We will focus on Wednesday’s CPI data.
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