Latest U.S. Inflation Data Unlikely to Ease Worries Over Treasury Yields

Introduction

The latest U.S. inflation data is unlikely to ease worries over persistently high Treasury yields that have gnawed on stocks over the last few weeks, investors said, although many believe the longer-term trend of cooling consumer prices remains intact.

Inflation Data

• U.S. consumer prices climbed by 0.6% in August, broadly in-line with economists expectations.
• In the 12-months through August, the CPI jumped 3.7%, though year-on-year consumer prices have come down from a peak of 9.1% in June 2022.

Impact on Interest Rates

While the latest data does not necessarily argue for more rate increases, it did little to dispel expectations that the Federal Reserve will leave interest rates at current levels for longer than previously expected, a view that has boosted Treasury yields while dulling the allure of stocks since the equity market peaked in July.

Market Outlook

• With the S&P 500 already up over 16% year-to-date and stocks richly valued by some metrics, some investors believe equities will struggle to make headway for the rest of 2023.
• Falling valuations for risk assets may be “the next shoe to drop” for the U.S. stock market.

Expectations for Rate Hikes

• Futures tied to the Fed’s funds rate now show a 45% chance of at least one rate hike by December, up from a roughly 31% chance seen a month ago.
• Markets now anticipate that the Fed will cut rates for the first time in July 2024, compared with expectations a month ago that rates would begin falling by March.

Impact of Rising Treasury Yields

Rising Treasury yields can be a stumbling block for stocks as they offer investors returns on an asset that is seen as basically risk-free because it is backed by the U.S. government. The benchmark 10-year Treasury yield was up 2 basis points on Wednesday to 4.284%, putting it about 6 basis points below its highest level since 2007. The S&P 500 is down 3% from its July highs.

Concerns About Stock Valuations

JPMorgan has warned that a metric based on real interest rates shows the S&P 500 is over-valued by 14%. The firm estimates that the current real rate implies a forward price-to-earnings (P/E) ratio of around 15 times to 16 times versus its current ratio of about 20 times. Some believe this relationship is becoming increasingly unsustainable.

Alternative Market Risks

Not everyone believes high yields are currently the market’s biggest risk. Some experts believe the market is vulnerable to an “earnings shock” to one of the megacap stocks that have led markets higher this year, such as Nvidia. Companies will begin reporting third-quarter earnings next month.

Conclusion

The latest U.S. inflation data has not eased worries over persistently high Treasury yields. While the longer-term trend of cooling consumer prices remains intact, investors are concerned about the impact on stocks. The Federal Reserve is expected to leave interest rates unchanged, but there are expectations for rate hikes in the future. Rising Treasury yields and concerns about stock valuations are putting downward pressure on stock multiples and increasing the risk of volatility. However, alternative risks, such as an “earnings shock,” may also impact the market.

Reporting by David Randall; Editing by Ira Iosebashvili and Sharon Singleton

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