Freedom: Treasury yields have accelerated to their highest level since 2007

Strong business activity (PMI) in the U.S. has reinforced expectations of further rate hikes by the Federal Reserve and pushed the yield on 10-year Treasuries to 5.13%—the highest level since 2007, Freedom Broker analysts note. High rates limit the equity market’s recovery potential, especially for small companies with heavy debt loads.

Yields remain the main risk for equities

The primary source of pressure on equities remains elevated Treasury yields, Freedom Broker analysts emphasized. U.S. Treasury bonds, or Treasuries, are considered the baseline risk-free asset for the global financial market. When Treasury yields rise, investors can earn higher returns with relatively low risk, making equities as a capital-growth instrument less attractive. 

At the close of trading on September 23, the yield on 10-year Treasuries rose by about 15 basis points to 5.1%, and on the morning of September 24 it reached 5.13%. The yield on 2-year notes also increased by about 15 basis points to 4.89%.

Business activity beat forecasts

The catalyst for repricing rate expectations was the preliminary September S&P Global business activity indices. The manufacturing PMI rose to 57, although the consensus expected it to fall to 53.6. The services activity index climbed to 58.7 versus a forecast of 56.

PMI reflects the state of business activity: a reading above 50 indicates expansion, while below 50 indicates contraction. The actual results significantly exceeded expectations and showed that the U.S. economy is maintaining a strong pace of growth.

At the same time, S&P Global recorded intensifying price pressures. The combination of resilient economic activity and accelerating prices raises the risk that the Fed will have to keep monetary policy tight for longer or raise rates further to bring inflation back to its 2% target.

The possibility of further policy adjustment was also raised by Federal Reserve Board Governor Michael Barr. His comments amplified the negative reaction in the bond and equity markets. Barr supported the recent rate increase and said that in his base-case scenario, the Fed will likely need to further adjust monetary policy in order to bring inflation back to the 2% target in a timely manner. 

Tech giants deepened the decline

In trading on September 23, shares of Nvidia (NVDA), Alphabet (GOOGL), Amazon (AMZN) and Broadcom (AVGO) together accounted for about 49 of the 72 basis points of decline in the SPDR S&P 500 ETF Trust (SPY). Semiconductor makers, including memory-chip companies, lagged the market, while software and cybersecurity solution developers looked more resilient: Palo Alto Networks (PANW) and CrowdStrike Holdings (CRWD) gained about 5% each.

In the next session, there was no broad-based rebound. By the close on September 24, Alphabet shares rose 1.35%, Amazon was virtually unchanged, up 0.03%, while Nvidia fell 0.40% and Broadcom declined 1.33%. Palo Alto Networks lost 0.87% and CrowdStrike fell 1.10%, partially giving back the prior day’s gains. The SPY fund slipped 0.07%.

According to Freedom Broker, high bond-market yields are still limiting the possibility of a sustained recovery in equities for now. The most vulnerable remain segments whose valuations are more sensitive to interest rates, while the energy sector may find support from high commodity prices.

Not an individual investment recommendation.