Want to Know Where Stocks Are Headed? Watch the 10-Year Treasury Bond Yield

October 10, 2022

The most powerful driver of the stock market this year is not the economy, it’s not earnings, it isn’t even Fed announcements of new interest rate hikes.  No, the driver of this year’s stock market is the yield on the 10-year Treasury bond.  When the yield (effectively the interest rate) goes up, stocks go down.  And when the yield goes down, stocks go up.

As we have said before, rising interest rates will hurt the stock market.  What’s fascinating is how closely rising and falling interest rates are correlated with rising and falling stock prices this year.  If you look at the big March rebound in stocks, you will see that the yield on 10-year Treasury bonds (aka, the interest rate) went down.  Then the big stock crash in May and June – the 10 year interest rate went up.  Then the big rally in July – the 10-year interest rate went way down, even though the Fed announced not one but two increases in the overnight interest rate.  The overnight rate increases that the Fed has been announcing don’t matter much to the market.  It’s the 10-year interest rate that matters.

Next, we had the big crash in September – the 10-year interest rate went way up.  The stock market is now a bit below its June lows.  Guess where the 10-year interest rate is?  Yep, a bit above its June highs. 

Although the day-to-day changes in 10 year rate don’t match the day-to-day changes in the stock market, the overall correlation is amazingly clear.  Interest rates are always an important factor in stock prices, but right now, they’re dominant.

Hence, if you want to know where stocks are heading, keep a close eye on the 10-year interest rate and almost nothing else. 

Currently the rate is 3.8%.  Expect stocks to fall dramatically if the rate goes over 4%, which could happen anytime in the next few weeks.

Want to Know Where the 10-year Treasury Bond Yield is Heading?

Just Look at the Fed’s Balance Sheet

The Federal Reserve’s Balance Sheet is essentially a record of all the money the Fed has printed to buy bonds and other securities using printed money.  You can find it at https://fred.stlouisfed.org/series/WALCL  It is updated once a week on Thursday evening. 

This is where the Fed controls the 10-year treasury bond yield.  When they increase their balance sheet by buying bonds with printed money, they push the yield (aka, interest rate) down.  When they decrease their balance sheet, they push the 10-year yield (interest rate) up. 

Since mid-April, the Fed has decreased their balance sheet by about $200 billion.  That’s not much.  For comparison, they were increasing their balance sheet by about $100 billion a month through March this year.  For a better comparison, the total balance sheet was $8.96 TRILLION in mid-April.  So, they have only reduced the balance sheet a relatively tiny amount – so far.  The Fed has promised to decrease their balance sheet by $95 billion a month, so we would expect the amount of decrease will go up.

However, even if the Fed never decreased its balance sheet, simply by not increasing it by printing more money to buy bonds puts upward pressure on interest rates.

That’s because the US needs to find enough money to feed the government’s $1 trillion plus annual deficit.  That’s a lot of money even for the US because that’s on top of all the money, you, me and all the businesses around us have to borrow for inventory, buying stock, expanding factories, housing, student loans, car loans, etc.

We simply don’t generate enough money each year to cover the needs of private industry and consumers, as well as massive government borrowing.  Even with foreign investors, we still need more money.  More money than our country can produce in savings to lend out.  Our savings rate is relatively low compared to many other industrialized countries (we like to spend!).  So, we HAVE to print money to feed the beast (the beast being the federal government’s deficit). 

And we have to run a big deficit or our economy won’t grow at all.  I want to emphasize this because it is so important:  Without enormous borrowing, we would have had no economic growth since the 2008 Financial Crisis.  This is what the Financial Crisis brought us – an economy entirely dependent of government borrowing for growth.

If the government doesn’t borrow massively, we won’t grow and will fall into a deep recession which will quickly cause the stock, bond and housing market bubbles to burst.  So, we have to borrow massively to keep from collapsing into a huge recession and in order to be able to keep borrowing massively we have to print money massively and continuously to keep interest rates from rising.  If we don’t print, interest rates will rise.

This is the enormous folly of the Fed’s current attempt to raise interest rates.  It is guaranteed to fail.  They can’t stop printing for too long or interest rates will rise due to massive government borrowing.  As interest rates rise, the stock market will be crushed. 

The Fed and Wall Street don’t want to understand or admit how important low interest rates are to keeping stock prices high. The same goes for real estate. And the same for bonds.  Any Finance 101 student learns this:  Falling interest rates push up the value of stocks, bonds and real estate.  Rising interest rates do just the opposite.

Why does the Fed and Wall Street not remember their Finance 101 class?  They don’t want to think about it because then they would be forced to face the fact that the Fed can’t raise interest rates and therefore the Fed has no way to control inflation. 

And if the Fed has no way to control inflation (because controlling inflation by raising interest rates would crash the markets and economy), then all the money we need to print to finance our massive government borrowing will eventually become highly inflationary – as in long term double digit inflation of 15 – 20%.

So, they are choosing to be delusional instead and think that they can raise rates after stock, bonds and real estate prices have soared massively due to low interest rates.  They can’t.  They will simply crash the market.  Asset prices are vastly higher today than when Fed Chairman Paul Volcker raised rates in the early 1980s.  We can’t do what Paul Volcker did without crashing stocks, bonds and real estate.  Volcker did not have to support super-high priced asset bubbles.  We do.

So, given all of the above, what is the likely path for the Fed’s doomed foray into raising interest rates? 

For the answer, please read our next article “When Will the Fed Be Forced to Quit?” which will be out in the next week.