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Investors Renew Battling With Rising Rates

Tonhe passed For three months, investors have barely paused to think. Since the Silicon Valley bank run (SVB) in March, the market had to judge first whether one US bank would fail (yes), then others (yes, though luckily few), and then whether the contagion would spread overseas (only to Switzerland credit). Bank failures appear to have tapered off with the takeover of another regional bank, First Republic, on May 1. But then, it’s time to worry about whether US politicians will default on their sovereign debt, throwing global markets into turmoil. At the time of publication of this column, they appear to have finally decided not to do so, provided a deal between President Joe Biden and Republican House Speaker Kevin McCarthy passes Congress.

All this drama has brought a kind of holiday to markets: It has given people a break from worrying about how high interest rates need to rise to keep inflation in check. Few things have mattered more to investors since the Federal Reserve started raising borrowing costs last March.but then SVBIn the fall, the question isn’t how much the Fed is prepared to do to fight inflation; it’s what it might need to do to stabilize the financial system.

Attention now returns to interest rates. Again, they’re on the rise. Yields on two-year Treasury notes, which are particularly sensitive to Fed policy rate expectations, fell as low as 3.75% in early May. The rate has since risen to 4.4% as officials briefed reporters that they were considering raising the rate further to the current range of 5-5.25%. Futures traders tied to rates, who until recently expected a rate cut within months, are now also betting on another rise.

The new mood music can also be heard outside the US. In the UK, former rate setters have warned that the Bank of England’s benchmark rate could rise to 6% from the current 4.5%. Yields on government bonds have climbed to levels not far behind last September, levels reached only amid the sell-off and market crash.

For Federal Reserve Chairman Jerome Powell, that could be a relief. In early March, he appeared to convince investors that the central bank was serious about raising interest rates and keeping them high. He and his colleagues spent months saying so; traders spent months trying to bluff. But then something changed in market psychology and investors ended up pricing in the same rate path as the Fed.Days later, turmoil erupted in the banking sector and depositors fled, and they quickly gave up their bets SVBThe market has now recalibrated itself and the Fed’s view of the world, which is considered a victory for the currency guard.

The return of rising interest rates is even more ominous for investors. Admittedly, part of the reason is that the economy started the year better than expected, and certainly better than feared after banks started failing. More importantly, however, inflation has been surprisingly stubborn. As of April, U.S. “core” prices, which exclude food and energy, were 5.5% higher than a year earlier. While recessions have been avoided or delayed, few forecast significant growth. In this case, rising interest rates are bad for stocks and bonds. They hurt stock prices by raising borrowing costs for companies and reducing the present value of future earnings. At the same time, bond prices were forced down to keep their yields in line with those prevailing in the market.

Does this mean another 2022-style crash? Certainly not in the bond market. The Fed raised interest rates by more than four percentage points last year. An extra percentage point or two this year won’t have the same effect.

Still, the stock looks vulnerable on two fronts. One is that most of the stock market lost momentum some time ago.this Second&p The Big U.S. 500 index is up 10% this year, but the overall gain has been less than that of its seven largest tech stocks, which all appear to be suffering AI Euphoria. Such narrow gains based on market sentiment can easily be reversed. A second source of market vulnerability is yield yield, which provides a quick and dirty guide to potential returns.this Second&p The 500 Index was at 5.3%. That means shareholders are taking the risk of holding shares for the expected return that the Federal Reserve may soon provide risk-free. Stay tuned for more exciting events.

Learn more from our financial markets columnist Buttonwood:
US Credit Cycle at Danger Point (May 24)
How to Invest in Artificial Intelligence (May 17)
Investors brace for painful collapse of US debt ceiling (May 10)

Plus: How the Buttonwood column got its name

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