Selloff continues in stocks; investors fret over high bond yields

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Yields saw their climb erased on Friday as US stocks swung between gains and losses, reflecting the tug of war between a classic flight to quality response and growing fears bonds are in a bear market.

Only last month the Dow and benchmark S&P 500 index had their best monthly gains in two years, with stocks reaching record levels on January 26, supported by the benefit of a cut in US corporate taxes in December, rising earnings, and healthy global economic growth. However, a flight to safety away from stocks and back into government bonds knocked the 10-year back down to 2.82% by early afternoon.

During its recent rally, the domestic stock market was overlooking the rising bond yields on some "misguided view" about earnings and macro-economic factors being less relevant for the equity market against ample global liquidity, Kotak Institutional Equities said in a recent note.

The bond market is ready to turn up the heat even more on the stock market.

A market correction is usually defined as a drop of more than 10 percent from recent highs.

But many equity markets were already in negative territory last week owing to rising bond yields and profit-taking. "Today it feels like leadership is going back to the rate market and now stocks are reacting to it", said John Briggs, head of strategy at NatWest Markets. Overseas, the Bank of England will announce its latest interest rate decision, along with its inflation report, due out around 7 a.m. ET.

Since the bond scare began about a week ago and the 10-year Treasury yield hit a four-year high of 2.88%, the Dow Jones industrial average has tumbled as much as 10.7% from its January 26 high and has behaved erratically.

The current earnings yield for the S&P 500 index companies stands at 5.4 percent, below the 6.4 percent average of the past 20 years.

"I would not be at all surprised if bond yields get beyond 3% by the end of the year as a result of inflation".

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In a speech on Monday, European Central Bank President Mario Draghi said the bank was increasingly confident that inflation would rise along with economic growth, but currency market volatility is a potential obstacle.

The Federal Reserve combats inflation by raising its interest rates. Traders are now putting the chances of a 25 basis point hike by the Fed at its March meeting at 84.5 percent, according to Thomson Reuters data.

The 10-year notes last rose 38/32 in price to yield 2.7093 percent, down from 2.852 percent late on Friday. The 10-year Treasury yield went over 2.85% for the first time since January of 2014.

The Dow Jones Industrial Average fell almost 1,600 points for its biggest intraday drop in history in points terms, or more than 6.0 percent, before ending down 1,175.21 points, or 4.6 percent for it's biggest one day fall since August 2011.

"This is the beginning of more meaningful setback in a market that was, at least from the nonfinancial sectors, very overvalued and there was a lot of euphoria", said Jonathan Garner, a global emerging market strategist at Morgan Stanley. This pushed up USA bond yields sharply, which in turn hit equity investor sentiments.

On Friday, New York's Dow closed down 666 points, with the S&P and Nasdaq also down sharply.

A visitor is seen as market prices are reflected in a glass window at the Tokyo Stock Exchange (TSE) in Tokyo, Japan, February 6, 2018. "The catalyst needn't be big". The strength of the global economy and corporate earnings are still providing support for stocks. Relative to yields, Treasuries now trade at roughly 37 times the annual interest payout, which in a rough sense might be considered their earnings.

"But it doesn't do much for predicting short-term moves". Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication. It is not a solicitation to make any exchange in commodities, securities or other financial instruments.

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