Bond Market Turmoil And The S&P 500

Are interest rates on long term bonds rising because of expectations of post-Coronavirus Recession growth? Or are they rising because the specter of inflation is becoming a real problem?

The as yet unknown answers to these questions is having an effect on the U.S. stock market, because bond investors have hedged their bets on bond yields over the past year by buying up high-flying tech stocks. For them, rising interest rates on bonds means losses, which they can and have offset by selling their tech-heavy stock holdings.

That dynamic helps explain why the tech-heavy Nasdaq has born the brunt of recent drops in stock prices in recent weeks, where the S&P 500 (Index: SPX) has been affected because of where the index overlaps those stocks. As you can see in the latest update to the alternative futures chart, the S&P 500 has generally risen along with the stocks that will benefit most from a post-Coronavirus Recession recovery.

(Click on image to enlarge)

Alternative Futures - S&P 500 - 2021Q1 - Standard Model (m=+1.5 from 22 September 2020) - Snapshot on 19 Mar 2021

The Federal Reserve, for its part, announced on Wednesday, 17 March 2021 that it would keep the short-term interest rates it controls at or near the zero level, indicating they are willing to allow inflation room to rise. On paper, setting that expectation should boost tech stocks, which is what happened after the Fed's meeting.

But the Fed isn't the only institution whose policies affect interest rates. On Friday, actions by the U.S. Treasury Department contributed to an environment where short term interest rates for U.S. Treasuries dropped below 0% and became negative, as President Biden's "stimulus" spending starts to get underway, dramatically increasing the amount of money the U.S. government borrows. The Fed's minions signaled they were comfortable with allowing interest rates become negative, which is a change from the expectations they had previously set.

The sudden arrival of negative short term interest rates and rising long term interest rates spells turmoil for the bond market, which will affect the stock market.

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