Worries Rise as Markets Drop

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Yesterday was another bad down day in the markets. Not only that, but other assets are getting hit as well, with bitcoin getting hit even more than the general financial markets. As worries rise, when will the bleeding stop?

Keep an Eye on Rates

As I have written before, it all comes down to valuations, which means it all comes down to interest rates. The higher interest rates go, the lower stock valuations will go. When we look forward, interest rates are what we need to watch. Here, there may be some encouraging news.

Since stocks are long-lived assets (ideally, a company will be around indefinitely), the best proxy for those valuations is longer-term interest rates. Most analysts use the U.S. Treasury 10-year yield as a benchmark. This is illustrated in the chart below, which covers the past 10 years, or roughly the period after the financial crisis to now.


Note a couple of things. First, we have seen two prior periods where the Fed was hiking short-term interest rates and long-term rates responded, in 2013 and 2016–2018. The 2013 increase was by far the faster of the two, with rates going from about 1.75 percent to just over 3 percent; in 2016, we saw rates jump from about 1.5 percent to 2.5 percent, then stabilize before jumping in 2018 from about 2.25 percent to just over 3 percent in 2018. In both cases, we saw rates go from 1.5 percent to just over 3 percent, before stalling and falling back.

This is relevant because that is exactly what has happened this year, with rates spiking from around 1.5 percent to just over 3 percent—just as we have seen two times before. This is the third time this has happened in the past 10 years.

I think those two cases have some useful lessons for where we are right now. In both prior cases, notice, rates peaked and dropped back, as higher rates slowed growth and prompted the Fed to cut again. We are already seeing signs that growth may be slowing this time as well. For interest rates, for example, post-financial crisis the yield on the 10-year has not been able to move sustainably above 3 percent. That suggests that the current interest rate spike may be topping out. Indeed, yesterday saw a bit of a rally in the bond market, suggesting that might be happening.

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