Key Takeaways
- Treasury yields spiked on Wednesday after a Treasury debt auction suggested concerns about unsustainable government deficits are eroding demand for federal debt.
- Morgan Stanley analysts in a note earlier this month forecast yields at their current level would spill over into the stock market and pressure valuations.
- Credit rating agency Moody’s on Friday downgraded U.S. government debt as Congress crafted a tax and spending bill that’s expected to add trillions to America’s public debt.
Treasury debt continued its wild ride on Wednesday, with yields soaring amid concerns about the U.S. government’s unsustainable deficit spending.
The yield on the 30-year Treasury bond surged as high as 5.1%, its highest level since November 2023, on Wednesday after a surprisingly weak 20-year Treasury note auction. The 10-year Treasury yield, which influences interest rates on all kinds of consumer and commercial loans, climbed to about 4.61%, its highest level since February.
The Treasury on Wednesday announced the results of a 20-year note auction in which demand was notably weaker than in last month’s sale. The auction’s highest yield rose to nearly 5.05% from 4.81% a month ago, while the bid-to-cover ratio, a common measure of demand, fell to 2.46 from 2.63.
Rising yields weighed on stocks. The S&P 500, trading marginally lower at midday, tumbled to finish the session down 1.6%, notching its second consecutive day of declines.
Higher Yields Pose Problem for Stock Market
Yields at their current levels could pose a problem for the stock market. Not only do high yields translate into higher interest rates on consumer and commercial loans, they also reduce the appeal of risky assets.
“A break above 4.50 is likely to turn the equity return/bond yield correlation meaningfully negative again, thus pressuring valuation,” wrote Morgan Stanley analysts, referring to the 10-year yield in a research note earlier this month.
Stocks, having sharply rebounded from their steep losses in April, are currently trading at relatively rich valuations. The S&P 500 as of Friday’s close had a P/E ratio of 23.82, above its 10-year average of about 18.
Investors Focused on GOP Tax and Spending Bill
Yields have been trending higher since the beginning of the month when signs of easing trade tensions reassured investors the U.S. will avoid a recession this year. The Federal Reserve’s cautious approach to interest rate cuts has also caused investors to reset their rate expectations, fueling the rise in yields.
This week, yields have been nudged higher by the GOP tax and spending bill currently working its way through Congress. The bill, which would extend and add to many of the tax breaks enacted by the Tax Cuts and Jobs Act passed in President Trump’s first term, is expected to dramatically increase the federal deficit over the next decade.
America’s ballooning deficit has caused investors across the globe to question U.S. debt’s status as the world’s premier risk-free asset. Moody’s on Friday became the last of the major credit rating agencies to strip the U.S. of its AAA credit rating, the highest possible score.
