What, if anything, are rising Treasury yields signaling

Key points:

• Every single Treasury yield, ranging from two to ten years, closed at a 3-month high
• Similar breakouts in yields suggest interest rates could continue to creep higher
• Stocks tended to struggle when yields across the curve break out on a medium-term basis    

Keep an eye on interest rates

After reaching a peak in autumn 2023, Treasury yields steadily declined for several months. The easing in rates spurred a surge in risk appetite, leading to a fervent rally in stocks.

With economic activity showing resilience and consumer inflation stabilizing, interest rates began to inch upwards once more, reaching a climax last week as Treasury yields spanning 2 to 10 years hit their highest levels in three months.

The previous yield breakout occurred in June 2023, one month before a peak in equity indexes, culminating in a 10% correction in the world's most benchmarked index.

Treasury yield breakouts set the stage for higher rates over the medium-term

When every single Treasury yield ranging from two to ten years closed at a three-month high, with four out of five yields exhibiting a rising 200-day average, the 10-year yield tended to rise further, especially over the ensuing three months.

After the June 2023 signal, the 10-year yield climbed 73 basis points in three months, the most significant increase over that period since 1984.

Following a breakout in Treasury yields, it was customary to observe additional upside follow-through in rates across the entire curve over a medium-term horizon.

With rates potentially drifting higher, stocks could struggle 

With interest rates showing a propensity to rise further over the medium term after similar breakouts, history suggests the S&P 500 could struggle over that same time frame. 

Following the June 2023 signal, the S&P 500 continued its upward trajectory for another month. However, investors eventually heeded the warning sign from rates, leading to a 10% correction in the world's most benchmarked index. 

Consumer Staples, a defensive sector, outperformed all other groups over the subsequent three months. Once stocks adjusted to the higher rate environment, often a sign of improving economic activity, Industrials outpaced all other groups a year later.

Bond Strategies

In a recent research report, I highlighted that the 3 to 7-year Treasury relative strength strategy had rotated to cash. Since that publication, several other models have shifted in favor of a cash proxy instead of bonds. If the interest rate environment turns more hostile, cash could once again be king.

What the research tells us...

Treasury yields across the curve have drifted higher, culminating in an interest rate breakout, all within long-term uptrends in yields. Whether due to a resilient economy, a stabilization in consumer prices, or a combination of both, it's nearly impossible to pinpoint the exact cause. We'll leave the guessing game to others. What we do know based on historical data is that after similar breakouts, yields could rise over the medium term, pressuring stocks. As we've stated several times, equity indexes rarely go up in a straight line. Usually, it is two steps forward followed by one zag sideways or down, a perfectly typical scenario in bull markets.