As of last Tuesday, the US dollar reached its highest level since November of last year, and the US 10-Year Treasury Note yield reached its highest point since 2007 on Tuesday of roughly 4.7%. This caused the stock market to freak the f**k out, with the Nasdaq Composite falling 1.6%, which is about 9% lower than its high in July.
While all of this may sound a bit scary, (especially if you are trying to get a mortgage) in reality all of these moves are highly correlated.
Rising rates make the dollar stronger because it is more valuable to park your money in US dollars vs. other currencies if you are getting paid more to do so. Meanwhile, higher rates and a stronger dollar mean that the earnings of companies in the future (how we value stocks) are now less valuable.
The chart below shows how rates and the dollar are directly correlated and how they are inversely correlated to stocks.
Yellow is the Nasdaq Composite, which has suffered over the last month.
White is the dollar index, and orange is the 10-Year Treasury Note rate.
Rates/Dollars Up = Stocks Down, easy game right?
Well, that’s what a lot of experts thought. But if we zoom out over the last year stocks (yellow) rallied despite interest rates (orange) ripped higher.
So what gives?
Once again all roads lead back to actions taken by our old frenemy the Federal Reserve (the Fed). Although there have been positive trends in the US dollar and government bond yields for several months, the recent release and press conference by the Fed accelerated the rise in interest rates to new multi-year highs. This caught investors off guard, and they had to adjust to the expectation of even higher rates for a longer period.
Markets always react to future expectations, so midway through this year, the market was saying inflation was dead (how many times can we be wrong about this). So when the market realized they were wrong about this and the Fed would keep rates higher for longer, 10-Year Notes reacted and at some point, this started to scare stocks, as we can see in the charts above.
BOND*
If the current market moves are finished, stocks may have already paid a significant price, and they could start rising again after this "healthy" setback. However, historical patterns indicate that we might still be a few weeks away from that point.
What’s the Upside?
In the end, these developments might give hope to stock investors that once the turmoil in bonds and currencies settles, stocks can regain their stability. Eventually, interest rates and the dollar will find a new balance, and riskier assets like stocks could see higher prices. Until then, there might be more rocky times ahead for stocks.