Global Stocks Sink On Rising Bond Yields Ahead Of Critical US Reports — A Typical Correction Or Something More Serious?

Global stock markets were sinking Thursday morning, ahead of several key U.S. economic reports, including the Gross Domestic Product (GDP) and the Personal Consumption Expenditures (PCE) price index. These reports are crucial indicators of the health of the U.S. economy and can significantly influence market sentiment.

At 2 a.m. ET, Asian shares were down across the board, with the Asia Dow down 1.24%, the Nikkei down 1.62%, and the Hang Seng down 1.43%.

The sell-off spread over to the U.S. market, with the Dow Futures down 328 points and the Nasdaq Futures down 129 points.

Global equities are selling for a second day, thanks to elevated inflation and the issuing of government debt pushing bond yields higher worldwide.

The benchmark 10-year Treasury bond is currently trading at 4.60%, up 0.12% for the week. The U.K. 10-year Gilt is at 4.41%, up 0.17%, and the German 10-year Bund yield is at 2.68%, up 0.14%.

Rising government bond yields are hurting stocks in several ways. First, they make bonds more appealing to conservative investors searching for stable returns.

Second, rising bond yields lead to higher interest rates across the economy, raising corporations' cost of borrowing and compressing profit margins.

Third, rising interest rates can slow economic growth and push the economy into recession, leading to lower profits and lower stock prices. This is because higher interest rates increase the cost of borrowing for consumers, reducing their spending power and potentially leading to a decrease in corporate revenues and lower stock prices in the cyclical sectors.

Fourth, government bond yields are the discounting factor in almost every equity valuation model. When interest rates rise, future earnings are less valuable when discounted to the present, leading to lower stock prices.

The critical driver behind rising bond yields worldwide is stubbornly high inflation, thanks to robust consumer spending in the world's largest economy and supply-side pressures. These pressures prevent central banks from easing monetary policy.

Then, new government debt is issued, raising the demand for loanable funds, and putting additional pressure on bond yields. For instance, U.S. Treasury yields rose Wednesday following the sale of 17-week, 2-year, and 7-year debt auctions.

The combination of elevated inflation and the proliferation of debt issuing could push bond yields even higher, making the stock correction more serious.

Traders and investors are anxiously anticipating the U.S. government's fresh data on GDP and the GDP price deflator today and the PCE tomorrow. These reports will provide crucial insights into the state of inflation, guiding future investment decisions.

Carol Schleif, chief investment officer of BMO Family Office, maintains a positive outlook on U.S. equities, providing a reassuring perspective amidst the market turbulence.

"From a momentum standpoint, new stock market highs tend to beget more new highs," she said. "While sentiment is strong, we are not seeing signs of over-exuberance just yet, as the market climbs the proverbial wall of worry grappling with interest rates, inflation, and Federal Reserve uncertainty. Consumers, companies, and businesses are all adjusting to the new normal of elevated interest rates. While interest rates are higher than a few years ago, they are still relatively low by historical standards."

Schleif believes technology stocks should continue to perform, especially as companies spend on the next digital revolution, artificial intelligence. "The strength in technology stocks is here to stay, but not necessarily at the expense of other sectors, as we expect participation from the health care and industrial sectors, too," she added.

"Artificial intelligence pushes every industry into a steeper learning and productivity curve, and AI has the opportunity to improve many services and employment-heavy industries, which few innovations in prior cycles have been able to do," Schleif said.

As of Friday's critical PCE report, Schleif doesn't expect any significant upward or downward surprise as the U.S. economy grows at moderate rates. "We continue to think the obsessive focus on Fed policy misses the important mark of the underlying health of this economic and innovation cycle," she added.