Interest rates

Interest rates climbed on the employment news. Why stock investors should worry.

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Traders work on the floor of the New York Stock Exchange on Friday.

Spencer Platt/Getty Images

Friday’s jobs report pushed short-term interest rates higher, but there is still plenty of room for them to rise. This could spell trouble for the stock market.

The Bureau of Labor Statistics reported that the United States added 467,000 jobs in January, more than the 150,000 expected. Wages rose 0.7% month-over-month.

This portends higher inflation which the Federal Reserve is now determined to reduce. The Fed is expected to raise its benchmark lending rate four times this year, but the odds of further increases are growing.

Expectations of more pushed the yield on 2-year Treasury debt, reflecting investors’ view of the short-term interest rate situation for the next two years, up to 1.3% against 1.22% just before the publication of the employment report. Yield has now more than tripled over the past three months.

But he probably hasn’t finished climbing. If the Fed does raise rates more than four times over the next one to two years, the benchmark policy rate — the cost of overnight lending among banks — will hit at least 1.25%. Five rate hikes would take the benchmark rate to 1.5%.

The 2-year Treasury yield is also expected to rise as investors demand additional compensation to cover the risk of holding a security longer. There is “still room for more hawkishness to be reflected in the front-end,” wrote Ian Lyngen, head of US rates strategy at


BMO
,

after the publication of the employment report.

It is not inconceivable that the 2-year yield will land around 2%. Its recent gain was fast enough — and the Fed is likely to raise rates more than four times — that the yield could hit 1.75% fairly quickly, said John Kolovos, chief technical strategist at Macro Risk Advisors. “The trajectory is very steep, so it would probably happen relatively soon,” Kolovos said.

Such a rapid ascent would likely cause more pain in the stock market. Higher interest rates aim to reduce economic demand, which could reduce earnings and hurt stocks. The market has already shown that a rise in 2-year yields will drive equities lower. The yield is up from 0.73% at the start of the year, while the


S&P 500

is down 6.4%.

This is a very different dynamic from that seen at the start of last year. In the first three months of 2021, the 2-year yield rose alongside a rising S&P 500. Stocks were rising because the economy needed to grow explosively – and it did – leading to higher corporate profits. The 2-year yield rose because investors thought all that growth would lead to inflation and higher interest rates, but they weren’t particularly worried.

Rapid earnings growth outweighed concerns about rising interest rates and, in any case, the Fed was still a long way from communicating its plans for monetary policy tightening.

It’s a different time now. Markets, including stocks, may not value rate increases.

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