The Real Fear Hanging Over Stocks Isn’t a 5% Treasury Yield but Falling Long Rates on Recession Angst: Analysis

A 5% U.S. 10-year Treasury yield isn’t the problem

The return of the fear of "R"

The real problem comes when long-term yields fall on growth worries

In 2022, an inverted yield curve sent the S&P 500 down 24% over nine months

Stock investors are on edge as the yield on the 10-year U.S. Treasury has climbed above 5%, but brokerage analysts increasingly say a drop in long-term yields could be the bigger threat. If yields fall because the growth outlook is weakening, that could spill into a recession. If short-term yields rise on inflation pressure while long-term yields fall on slowing growth, that may signal the bond market is once again pricing in fear of an "R" — recession.

According to the financial investment industry on October 10, the U.S. Treasury sold 10-year notes at a high yield of 5.300% at an auction held on October 7. That was the highest awarded yield since November 2000. The 10-year Treasury yield in the secondary market also moved above 5% at the close on September 23 and has kept rising, recently trading around 5.3%.

Kim Jun-young, an analyst at iM Securities, said the recent rise in yields has been driven by higher real rates tied to growth expectations. Stocks have been rallying, with the S&P 500 closing at a record 7,818.93 on October 6. It also set an intraday high of 7,844.52. Stock indexes are a leading indicator of the economy.

Kim's view is that investors should be more wary of the moment long-term yields stop rising and begin to fall. Rising yields are not the cause of an expansion but the result of one, he said, adding that rates simply follow growth. A decline in yields caused by fading growth should be read not as a positive but as a warning. Once slower growth starts pulling yields lower, weak economic data may no longer be interpreted as boosting hopes for Federal Reserve easing, but instead as a signal of weaker corporate earnings.

That view also aligns with the market’s traditional reading of short- and long-term yields. In financial markets, short-term yields are typically used as a gauge of monetary policy expectations, while long-term yields reflect the medium- to long-term growth outlook. If inflation strengthens expectations for Fed tightening and pushes short-term yields higher while recession worries drive long-term yields lower, the gap between the two can narrow quickly.

Recent inflation data have already raised concern. The Institute for Supply Management’s manufacturing prices index came in at 77.9, well above the market forecast of 72.9. Its services prices index also rose to 74.0 from 72.6 a month earlier.

Lee Eun-taek, an analyst at KB Securities, said the market begins pricing in Fed tightening when worries about persistent inflation build. In that environment, short-dated Treasury yields can rise quickly. The 2-year Treasury yield climbed 12.34% last month, outpacing the 10-year’s 11.24% increase.

The picture could worsen if signs of slower growth emerge as well. If concerns about cooling AI investment or a broader economic slowdown intensify at the same time, long-term growth expectations would weaken, Lee said. In that case, long-term yields may stop rising and could even fall. The moment short-term yields rise while long-term yields decline could become a key warning signal.

Short-term yields are usually lower than long-term yields. That is because lenders demand additional compensation for the risk of tying up money for longer periods. The spread banks earn by borrowing short from depositors and lending long to companies is one of the industry’s core profit models.

The problem comes when short-term yields rise above long-term yields. If banks become more conservative after that profit model breaks down, money stops circulating smoothly through the economy, which can damage growth. To overcome that kind of environment, a powerful new growth engine, such as technological innovation, needs to emerge.

Investors can look back to 2022. It was the late stage of a boom fueled by loose monetary policy introduced to overcome the Covid-19 pandemic, just as inflation tied to that policy and the Russia-Ukraine war surged with a lag. The Fed raised interest rates sharply to contain inflation, but growth expectations failed to keep pace and stocks stumbled badly. The S&P 500 fell 24.77% in the first three quarters of 2022. The market was able to rebound only after ChatGPT’s release on November 30, 2022, helped revive expectations for growth in the artificial intelligence industry.

Still, Lee said it is not yet time to worry about an inverted yield curve and the return of recession fear. For now, the picture is the opposite. Long-term yields are still rising, while short-term yields have recently pulled back. The 2-year Treasury yield has fallen 0.11 percentage point this month through October 7.

Han Gyeong-u, Hankyung.com reporter case@hankyung.com