September was been a difficult month for US stocks and government bonds as markets added to bond’s risk premia partly in response to guidance from the Federal Reserve that interest rates are set to stay higher for longer than previously anticipated.
The S&P 500 stock index fell more than 5% in September — pulling it toward its first quarterly loss in 12 months.
The rise in bond yields since the start of August accelerated in the last week of September after the Fed projected a higher path for interest rates in 2024 and in 2025 than investors had expected.
The yield on 10-year US Treasuries rose from around 4.39% in the wake of the Fed’s meeting on 20 September to as high as 4.60%, its highest level since 2007. It is on track for its biggest monthly jump in a year.
In addition to the prospect of policy rates being held higher for longer, the rise in (real) bond yields has been driven by an increase in term premia – the compensation that investors require for bearing the risk that interest rates may change over the life of the bond. The decline in term premia for US Treasury bonds over the last three decades has been ascribed to various factors including fiscal surpluses, a negative stock-bond correlation, increasing foreign demand for safe assets, and quantitative easing. In recent months, with some of these factors either going into reverse or on the wane, the trend seems to be reversing. As central banks continue to normalise their balance sheets, rebuilding of term premia could continue.
Higher interest rates have hit equities both through an increase in the discount rate leading to lower valuations, and through the impact of higher bond yields on the economy and corporate profits.
The S&P 500 is still up 11% in 2023 through September, but the rally has been concentrated in a small number of heavily weighted tech stocks whose valuations surged earlier in the year fuelled by excitement about artificial intelligence. In September, the equal-weighted version of the S&P 500 index fell back into negative territory for the year-to-date through September.
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