On Wall Street, the bond market sets the tone

The bond market dominated discussions on Wall Street this week. The yields on benchmark Treasury bonds that determine borrowers' interest rates, from first-time home buyers to international corporations, have steadily risen to their highest level in seven years.

The increase is kind of a double-edged sword.

On the one hand, rising yields reflects the strength of the economy. At the end of Friday, after a report showed that unemployment was at its lowest level since 1969, the 10-year note yield – or what the US government will pay to borrow from Money for a decade – was 3.23%. It has not been as high since May 2011.

But as rates rise, borrowing will also become more expensive for consumers and businesses, which could slow down growth. Higher rates also alter the balance of risk and benefits for investors in other markets. As a result, stocks fell, with the Standard & Poor's 500 stock index ending the week down more than 1%.

The idea that growth will push interest rates upward, but only for the purpose of slowing rates again, reflects the cyclical nature of the economy. At the moment, rates are somewhere in between – not high enough to hurt growth, but up and making some investors cautious. Here's what to do with all of this.

L & # 39; s economy

Bond investors are banking on the expansion

Government bonds are known as safe haven investments. People buy them instead of investing more at risk, such as stocks, corporate debt and commodities, because they worry about something: the economy, war, politics, and so on.

Bond yields move in the opposite direction of prices, so yields fall during these difficult times.

Since the financial crisis struck a decade ago, returns have been quite low. The yield on the 10-year note has spent most of the last decade below 3%. (The low point was below 1.4% in July 2016.)

These returns prevailed even as the US economy recovered. This is partly because the US Federal Reserve has taken extraordinary steps to try to restore the economy to its economy. But this also reflected investors' lingering doubts about expansion. Until recently, many investors have doubted that the economy can develop in the event of a trade war.

But increase it, as gross domestic product grew by 4.2% a year in the second quarter, and even some half-empty glass producers are convinced that a recession is not on the horizon. So, yields are increasing.

"The situation as a whole, the economy is very strong," said Tim High, interest rate strategist at BNP Paribas in New York. "The job market remains very strong."

In fact, the worry now is whether this growth will get too hot, which will result in faster inflation and push the Fed to raise interest rates faster than it would like .

According to Mr. High, for now, this is not a concern, which means that investors should not have any bad economic surprises.

L & # 39; s future

But everything will become more expensive

In the United States, we rely heavily on debt to fuel the economy. And when the cost of this debt increases, it can slow down growth.

We are on the verge of knowing what the weight of this weight will be.

As we have said, for much of the last decade, long-term interest rates – which are essentially fixed by the Treasury market – have been quite low. Higher rates now lead to higher borrowing costs.

The 30-year fixed rate conventional mortgage rates exceed 4.7%, the highest level since 2011. Similarly, interest rates on 48-month new auto loans increased by more than 5%. They had not been as high since 2012, according to the latest data from the Fed.

Traditionally, cars and homes play an important role in the US consumer-oriented economy. And if there is a weak point in an otherwise strong economy, it may be in these interest-sensitive sectors.

Sales of existing homes have declined in recent months. They were stable in August and down 1.5% from the previous year.

Automakers announced a sharp drop in sales in September. Part of this decline is due to hurricanes that caused floods in the Carolinas. But rising interest rates and rising car prices are also pushing some buyers into the used car market.

The stock market

And stocks will start to look less attractive

We often talk about financial markets – stocks, corporate debt, government bonds, commodities – as if they existed completely isolated from each other.

They do not do it.

Changes in one can often have significant effects on another. If oil prices go down, for example, the profits of oil pumping and gasoline refining companies will obviously stop. This will affect the stock prices of these companies and the stock market as a whole.

Similarly, higher yields on government bonds can have a subtle but important impact on the stock market. When rates go up, they can convince more and more people who have walked the bull market for nearly ten years on the stock to pull some of their earnings off the table and reduce them to government bonds. .

In the long run, this could start to take your breath off the sails of the stock market.