The Dow closed 1,500 points higher on Wednesday, boosted by Donald Trump’s decisive election win and a possible Republican-controlled Congress, signaling strong market optimism.
Alongside the stock rally, U.S. Treasury yields also increased, raising concerns amongst some analysts about market stability and the potential effects on equities.
The ten-year Treasury yield rose over 14 basis points, reaching 4.433%—its highest level since July. Similarly, the yield on the 2-year Treasury climbed by about 7 basis points to 4.274%, its highest since July 31.
Yields and bond prices move inversely – as yields rise, bond prices fall. This often indicates a shift toward safer investments, suggesting that investors could also be cautious about putting money into equities amid anticipated economic changes under latest leadership.
So what does an increase in Treasury yield indicate?
Goldman Sachs (GS) analyst David Kostin released a report on Wednesday detailing an updated outlook for the equity markets. Within the report, Kostin cautioned that a big rise in 10-year Treasury yields could constrain any sustained rally in stock prices.
“An extra sharp increase in 10-year Treasury yields would likely limit the magnitude of any potential rally in stock prices.” he wrote.
Kostin noted that, thus far, equities have managed to soak up higher yields, largely because improved economic data have driven the rise. Nonetheless, he warned that a continued rise in bond yields could narrow market gains, concentrating the rally inside certain stocks while limiting broader sector performance. This trend could reflect investor caution as higher yields make safer investments like bonds more appealing relative to equities.
Rate of interest cuts are on the horizon
Within the report, Kostin projected that the Federal Reserve would cut back the federal funds rate by 25 basis points on Thursday, bringing it right down to a goal range of 4.5% to 4.75%. He further anticipated a further quarter-point cut on the Fed’s upcoming Dec. 18th meeting. These rate cuts, in accordance with Kostin, are likely a part of the Fed’s technique to support economic growth amid evolving financial conditions and to offer some relief to borrowers as bond yields climb.