The 10-year Treasury yield hit 3% on Tuesday for the first time in more than four years, reflecting expectations that the Fed will hike its key rate four times in 2018. Stocks, which have struggled as Treasury rates have rallied strongly in recent sessions, sold off sharply yet again.
XFed expectations are fluid. Around 10 a.m. Eastern Time, the CME Group FedWatch page showed roughly 53% odds of a fourth quarter-point rate hike coming in December, up from one-in-four odds after the deceptively strong March jobs report two weeks ago.
But as the S&P 500 index and Dow Jones both closed 1.7% lower and the Nasdaq composite lost 1.3%, the 10-year Treasury yield pulled back to just below 3% and odds of a fourth Fed hike slipped to 39%.
Bank Stocks Outperform Higher Rates
Bank stocks were among the better performers in afternoon trade on the stock market today. But Bank of America (BAC) reversed lower for a 0.4% decline as the market closed, and JPMorgan Chase (JPM) lost 0.5%. Bank of America and JPMorgan Chase are both still below their 50-day lines.
Superregional Fifth Third Bank (FITB) surged 4.1% after soundly beating earnings estimates, but was well off session highs. West Coast-based Umpqua Holdings (UMPQ) gained 1.4%, extending its recent breakout.
Bank stocks can see a big benefit from higher long-term rates if the spread vs. short-term rates widens. But the big move in the 10-year in recent weeks has seen narrowing spreads.
While a higher 10-year Treasury means higher mortgage rates for home buyers, housing stocks got a lift initially Tuesday from strong earnings and housing data. Shares of PulteGroup (PHM) gapped higher on strong earnings, rising 2.9%, while Lennar (LEN) fell 1.7% and D.R. Horton (DHI) advanced 0.6%.
March new home sales rose 4% to a 694,000 annual rate, well above the 630,000 rate expected and not far off November's 11-year high. Also, the Case Shiller 20-City Home Composite Price Index rose 6.8% from a year ago in March, the best gain since June 2014.
Still, Tuesday's market action suggests, at least in the near term, that higher market interest rates may pose a hurdle for the S&P 500 and and the stock market generally as it aims to shake off the recent correction.
Inflation Accelerating
Since jobs day, the Labor Department reported that core consumer inflation accelerated to 2.1% from a year ago in March. And now higher oil prices, which once again rose to their highest level since 2014 on Tuesday, could add to upward pressure on prices.
At a minimum, the risk of another inflation undershoot has diminished. All the near-term risk is to the upside. That, in turn, could dampen demand for U.S. debt at a time when deficits are beginning to spiral higher and the Fed is curtailing its own holdings of Treasury and mortgage debt.
In a Tuesday note, Lewis Alexander, Nomura's chief U.S. economist, projected that the Fed's preferred inflation gauge, the core personal consumption expenditures price index, looks likely to rise to 2.3% by the end of 2019, up from 1.6% in February.
Core PCE inflation for March will be reported on Monday, April 30.
The Federal Reserve will meet on May 1-2 but isn't expected to hike rates again until the June meeting. Fed policymakers who want to move gradually but are concerned about the economy overheating will privately cheer financial markets moving proactively, essentially doing the Fed's work for it.
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