Why Interest Rates Matter to The S&P

This article was originally published on Nadex.com.

Yesterday we saw interest rates in the U.S. hit levels not seen for years. The 10-year note jumped up above 3% in a very real way, briefly topping 3.09%, highest since 2011. The 2-year note hit 2.58%, the highest in 10 years! The good news is since the beginning of May, the 2-year/30-year yield curve has only flattened by 1 basis point, but the 2- year/10-year has actually steepened by 3 basis points. That Is taking a bit of pressure off the Fed and you can see it in the probability of a rate hit for June. As of 3 days ago, the probability of a 25 basis point hike at the June 13th meeting was at 100%. Yesterday morning it was 95%, which may seem like it became 5% less probably but what actually happened was the probability of a 50 basis point hike on June 13th went from 0% to 5%!

So who cares?

The S&P 500 cares and so do stocks in general. As rates go higher, so does the cost of borrowing for business and this leaves businesses with less profit. Less profit means potentially lower share prices. This is what people mean when they say that the stock market is a “discounting mechanism”. Higher borrowing costs doesn’t immediately mean profits will suffer, it just means the risk of it happening are higher and the market demands compensation for that risk in the form of a discounted price for stocks. On top of that, investment vehicles, like treasury bills and notes and CD’s become competition for stocks once they are paying a respectable yield. Maybe not yet, but if they yields keep rising, money that was earmarked for buy and hold S&P funds may go into good old-fashioned CD’s or bonds. Even a 3-month bill now yield’s more than the S%P’s cumulative dividend yield.  As of Monday’s close, the S&P 500 had a dividend yield of 1.89% and the yield on 3-month Treasury bills hit about 1.91%, the highest level since June 2008. The only way to change that is for stock prices to go lower. They may not, but at least now it’s no longer a complete loser to sit in cash. That could hurt the bull market during periods 2018 if we get falling prices. When you don’t HAVE to buy the dip in the S&P to earn, often times you don’t.  

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