Wednesday, 16 Jan 2019

Stock market investors may be watching the wrong yield curve

Stock investors seem suddenly convinced that rising interest rates could kill the bull market and perhaps even economic expansion. This can be true. The problem is that they may be watching the wrong rate curve.

Equity investors appear to be most focused on the Treasury yield curve. This played a significant role in the Dow Jones Industrial Average's 799-point decline. Longer-term returns, such as five-year bonds and 10-year bonds, tend to be higher than two- or three-year bonds. The difference between these rates creates the yield curve. Investors must be compensated for the risk of holding long-term bonds, so these returns are generally higher. The curve is also a traditional indicator of economic expectations. The higher expected future interest rates suggest that investors think that economic activity will be more intense. But right now, the opposite is happening. The yields on two- and three-year Treasury bonds are about the same as or better than the five-year note. An inverted yield curve is often the sign of an impending slowdown.

But Jim Paulsen, chief equity strategist for the Leuthold Group, says the interest rate gap that should really worry investors is not the one that separates short-term treasury yields and the one in the long run, but the one that marks how much more companies are paying to borrow. . This shows how worried investors are that companies are not able to repay their debts, which would likely happen more frequently during a recession. And this differential has been most correlated with the movement of stocks, says Paulsen. The narrower the gap, the more advantageous it is for equities.

The gap between the average rate of 10-year BBB rated corporate bonds and 10-year treasury bonds is nearly 1.8 percentage points. This is higher than the 1.7% of the average gap over the last decade, but not much. And it's far from being the highest of other stress periods. Corporate bonds reported almost 2.3 percentage points higher than the public debt at the end of 2011 and early 2016. The gap was almost double what it is now at mid-2009.

Higher interest rates could eventually slow down the stock market. But the spread of the business does not yet sound the alarm.

To contact the author of this story: Stephen Gandel at

To contact the editor responsible for this story: Daniel Niemi at

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Stephen Gandel is an editorialist of Bloomberg Opinion, specializing in banking markets and equity markets. He was previously deputy digital editor of Fortune and blogger in economics at Time. He also covered the finances and the housing market.

© 2018 Bloomberg L.P.


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