US 10-year yield punches higher. What comes next for equities? US 10-year yield punches higher. What comes next for equities? US 10-year yield punches higher. What comes next for equities?

US 10-year yield punches higher. What comes next for equities?

Equities 3 minutes to read
PG
Peter Garnry

Head of Equity Strategy

Summary:  A new dynamic is likely taking shape in US equity markets as the US 10-year yield has punched through the 4% levels in a wild move following FOMC Minutes and economic data suggesting higher policy rates are needed to cool the economy. Higher long-term bond yields mean higher cost of capital and thus lower equity valuations unless the growth outlook improves. Therefore the stakes have been raised considerably going into the Q2 earnings season.


Key points in this equity note:

  • Long-term bond yields are breaking higher with the US 10-year yield pushing above 4% introducing a new dynamic in the US equity market that most had been downplaying for months during the AI rally.

  • The VIX Index has jumped significantly today coming out of its hibernation and the VIX futures forward curve is getting closer to inversion signaling nervousness.

  • With the cost of capital on the rise the stakes have been raised going into the Q2 earnings season. Higher discount rate on cash flows can only be offset by higher growth outlook so the Q2 earnings season is now paramount maintaining the strong equity sentiment this year.

A new dynamic is in play

We have been highlighting it multiple times in our daily podcast over the past couple of weeks. Inflationary pressures are still strong in the economy and the market would be surprised about central banks’ policy trajectory. The FOMC Minutes last night suggested more hawkish FOMC voting members than what was priced in and it immediately lifted bond yields across the board. We had flagged the possibility of the US 10-year yield breaking out above the 4% level and today it happened. We wrote the following on US equities in our morning Quick Take report:

US bond yields are moving higher as FOMC Minutes showed that most of the policymakers agree that more tightening is needed this year. If the US 10-year yield breaks above 4% and marches on to challenge the previous cycle highs around the 4.25% it could change the dynamics in the US equity markets. With rising bond yields a positive Q2 earnings season becomes more important to justify the current equity valuations under rising yields.

With the US 10-year yield marching higher with high energy trading at 4.05% of this writing the dynamics in US equities have indeed changed. S&P 500 futures are down 1.3%, the biggest decline since 25 April, erasing most of the recent gains. The VIX Index is jumping significantly in today’s session trading around 16.64 introducing suddenly a change of sentiment. The VIX futures forward curve has inched closer to inversion with the 2nd nearest contract trading only 1.4 points above the spot index which is lowest positive spread since the hectic days during the US banking crisis.

The higher US 10-year yield lifts the cost of capital and thus lower the present value of future cash flows, so unless the higher 10-year yield reflects higher growth it could cause a repricing lower of equities. With the rally in technology stocks due to AI, the US equity market has reached equity market valuations that make it more sensitive to these breakouts in bond yields. Because growth is important to offset higher cost of capital the stakes have been raised going into the Q2 earnings season. A normal small correction in equities as reality turns out not to be able to support elevated expectations is often in the 5-7% range which in the case of S&P 500 future could take those futures down to the 4,200 level. Whether a future path leads to this area will depend on what long-term bond yields do from here and whether companies disappoint or not on Q2 earnings against elevated expectations. It could turn out to be stormy summer.

S&P 500 continuous futures | Source: Saxo
US 10-year yield | Source: Bloomberg
VIX Index | Source: Bloomberg
Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.