U.S. markets seem a bit off to many observers lately: Bonds are in the grips of a punishing selloff, driving yields to roughly two-decade highs.
On the other hand, stocks are doing just fine.
The stock market's resilience has been a surprising, and broadly welcomed, subplot in the transition to higher interest rates. Now investors want to know how long it can last.
Rising bond yields can hurt stocks in a couple of ways. They lift borrowing costs across the economy, slowing growth. They also mean investors can earn more by holding new bonds to maturity, making them think twice about owning much riskier stocks.
Bond selloffs are especially dangerous during times like now, when yields are rising because the Federal Reserve is lifting rates or about to do so. That is different from when the economy is doing well and yields are ticking higher just because investors expect rate increases sometime in the distant future.
Even then, market history is complicated. Squint, and one can find many examples supporting the arguments of bulls and bears alike. Stocks have withstood surging yields before-though their especially poor performance just four years ago continues to haunt investors.
1994
The 1994 bond selloff is one of the most famous in history, and it began when the Alan Greenspan-led Fed raised rates that February.
That hike surprised investors because inflation was seen as tame; the Fed was only moving because it thought a strengthening economy could spur inflation in future. Investors didn't wait to see how it played out, furiously betting on a series of rate increases that drove the 10-year Treasury yield up more than a percentage point in just 40 trading sessions. The rapid adjustment also drove down stocks, with the S&P 500 falling as much as 8% from the start of the bond selloff.
Stocks gradually recovered even as yields continued to climb, reflecting confidence that the rate hikes wouldn't spur a recession and that a strong economy would continue to support corporate earnings.
1999
Yields surged again in 1999. This time, though, the bond market was ahead of Greenspan. The 10-year yield rose around a percentage point in the months leading up to the start of another series of pre-emptive rate hikes. Stocks were choppy for months-but again recovered as dot.com mania swept through Wall Street and superseded concerns about the rise in borrowing costs.
The S&P 500 reached its dot.com peak on March 24, 2000, then tumbled 49% to its bear market low in late 2002.
2006
By early 2006, surging oil prices were adding to inflation pressures. Yields jumped and the Fed raised rates, but stocks generally held firm until May when investors started growing more concerned about the economic outlook. Those fears initially drove stocks and yields down together, before yields started rising again in June.
2016
The bond selloff of 2016 was a textbook example of how yields and stocks sometimes rise together. Rather than a threat to growth, rising interest rates were welcomed as a sign that the economy might finally be normalizing after years of sluggish growth following the 2008-09 financial crisis.
Yields and stocks got an extra boost from a surprise Republican sweep in the November elections, as investors bet that President Trump and the new Congress would spur growth and inflation by cutting taxes and regulations.
2022
The bond selloff of 2022 was by some measures the worst in U.S. history. It was also a very bad year for stocks. Though Covid-spurred inflation arrived in 2021, investors had agreed with the Fed's assessment that the period of rising prices was transitory. So when the Fed pivoted and started to raise rates aggressively, many scrambled.
2026
Investors are once again at a crossroads. Though yields have climbed and the Fed has already raised rates once, economic growth has stayed resilient-fueled by historic spending on artificial-intelligence infrastructure by tech companies that seem impervious to rising borrowing costs.
That strength has supported stocks, and many don't see why it shouldn't continue-especially if a deal can be struck between the U.S. and Iran that would lower oil prices and reduce inflation pressures.
Others are more pessimistic, arguing that the Fed might have to keep raising rates until stocks finally feel pain since the lofty market itself could be an obstacle to conquering inflation.
Fed Chairman Kevin Warsh is focused "on the overall financial environment and whether or not that is slowing demand," said Meghan Swiber, senior U.S. rates strategist at Bank of America in an interview for a coming episode of WSJ's Take on The Week podcast. "You look at equities, you look at risk assets, there is very little signal to the Fed right now that anything is slowing down."
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