The Dow Jones closed 1,500 points higher on Wednesday, boosted by Donald Trump’s decisive election victory and a possible Republican-controlled Congress, indicating strong market optimism.
In addition to the stock rally, U.S. Treasury yields also rose, raising concerns among some analysts about market stability and the potential impact on stocks.
The yield on ten-year government bonds rose more than 14 basis points to reach 4.433%: the highest level since July. Similarly, 2-year government bond yields rose about 7 basis points to 4.274%, the highest level since July 31.
Interest rates and bond prices move inversely: as interest rates rise, bond prices fall. This often signals a shift toward safer investments, indicating that investors may be cautious about investing money in stocks in light of expected economic changes under new leadership.
What does a rise in government bond yields indicate?
Goldman Sachs (GS) analyst David Kostin released a report Wednesday with an updated outlook for the stock markets. In the report, Kostin warned that a significant rise in 10-year Treasury yields could hinder a sustained rally in stock prices.
“A further sharp rise in 10-year Treasury yields would likely limit the size of a potential rally in stock prices.” he wrote.
Kostin noted that stocks have managed to absorb higher returns thus far, largely because improving economic data has driven the rise. However, he warned that a sustained rise in bond yields could limit market gains, causing the rally to focus on certain stocks while limiting the performance of the broader sector. This trend could reflect investor caution, as higher yields make safer investments like bonds more attractive versus stocks.
Interest rate cuts are in the offing
In the report, Kostin predicted that the Federal Reserve would cut the federal funds rate by 25 basis points on Thursday, bringing it down to a target range of 4.5% to 4.75%. He further expected an additional quarter-point cut at the Fed’s upcoming meeting on December 18. These rate cuts are likely part of the Fed’s strategy to support economic growth amid changing financial conditions and provide borrowers with some relief as bond yields rise, according to Kostin.
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