Why Cheap Bonds Are Bad For Stocks
May 27, 2009 by Tisa Silver
Filed under Finance
Why would news of cheaper Treasury bonds send the stock market tumbling down? Two words: higher costs.
Let me explain. Bond prices and yields move in opposite directions. Right now, U.S. Treasury bonds are cheaper and their yields are rising.
Photo by Ryan McFarland, courtesy of flickr
The U.S. government is the most creditworthy borrower, and as such, rates on its bonds are used as the benchmark for issuers with more risk.
When the rate payable on government debt rises, it leads to higher rates on debt from other issuers.
So, the low rates, and perhaps, cheap financing some individuals and businesses have become accustomed to may be on the way out.
The threat of more expensive financing is not good for an already struggling Wall Street.
Today, the Dow and the S&P 500 both lost around 2 percent. The Nasdaq Composite fell about 1.1 percent. Interesting that the Nasdaq was punished the least, when it is believed to be the riskiest index of the three.
I think the state of the economy is still too questionable for an interest rate hike to take place anytime soon, and today’s selloff was a bit dramatic.
In the meantime, if you own stocks, check the balance sheet of each company you own. From there, you can gauge how much each company relies on debt financing (short-term and long-term). If the company has too much debt, then more drama could be coming to your way.
I think the long bond is rising either in anticipation of increased economic activity, or in response to the large debt issuances by the government, the perception that the government is becoming less credit-worthy and the Fed’s increase in the money supply. Either way, it is signally higher inflation ahead.