Bonds not ‘out of the woods yet’ — and that could mean trouble for stocks

Treasury yields fell on Tuesday, easing off 16-year highs that had spooked markets over the past week.

But Sofi head of investment strategy Liz Young told Yahoo Finance Live that the market’s latest “pain trade” might not be over.

“I don’t think bonds are completely out of the woods yet,” Young said. “We also haven’t seen very much weak economic data…At this point there hasn’t been a good reason for yields to come down and stay down.”

Young highlights that yields are moving down ahead of the latest read on inflation expected on Thursday. Last month’s Consumer Price Index report showed prices grew 3.7% in August compared to last year, an increase driven largely by rising energy prices. While economists surveyed by Bloomberg see inflation ticking down to 3.6% in September, Young is “not super optimistic” based on energy prices moving higher for much of the month.

Higher inflation could prompt the Fed to hike interest rates once more. Recent research from BlackRock shows the 10-year Treasury yield has closely tracked the Fed funds rate during this and other hiking cycles.

The kicker for stock investors would be if reaccelerating inflation sent bond yields rising again.

Stock price movements have been highly correlated to bonds recently. So a hot inflation report that sends yields higher would potentially not bode well for equities, which haven’t reacted well to instability in the bond market.

“If the market narrative near-term is the direction of interest rates, then the answer is this only reverses if interest rates stabilize,” Fundstrat’s head of research Tom Lee wrote on October 4.

A stream flows through Mogilsa Forest close to Reykjavik, Iceland on May 21, 2019. - Before being colonised by the Vikings, Iceland was lush with forests but the fearsome warriors razed everything to the ground and the nation is now struggling to reforest the island.
The country is considered the least forested in Europe; indeed, forests in Iceland are so rare, or their trees so young, that it is commonly joked that those lost in the woods only need to stand up to find their way. (Photo by Halldor KOLBEINS / AFP)        (Photo credit should read HALLDOR KOLBEINS/AFP via Getty Images)

A stream flows through Mogilsa Forest close to Reykjavik, Iceland on May 21, 2019. (Photo by Halldor KOLBEINS / AFP)

Josh Schafer is a reporter for Yahoo Finance.

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