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Evan Horowitz | Quick Study

Stocks are plunging. Blame bonds

Traders worked the floor of the New York Stock Exchange.
Traders worked the floor of the New York Stock Exchange. Sarah Blesener/Bloomberg News

Financial markets are slowly finding their way back to the old normal, that long-lost era before 2012 when bonds paid decent interest rates and mortgages were much costlier.

Tuesday morning, the yield on the 10-year Treasury bond kissed 3 percent, a level not seen since a heady few weeks in early 2014, and not sustained for any extended period since 2011.

Not everyone on Wall Street was cheered by the news. When bond yields rise like this, it gives investors new reason to shift money out of high-risk stocks into the safer and increasingly decent-paying bonds — which was part of the reason stock prices fell dramatically on Tuesday.

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The Dow Jones industrial average dropped more than 424 points, or 1.7 percent, to close at 24024.13. It was the Dow’s fifth straight session in the red, the longest losing streak since March 2017.

An earnings warning from a bellwether industrial giant, Caterpillar Inc., also fueled the decline.

Rising rates portend big changes for Main Street, too, including higher interest on your savings accounts, higher payments on your variable-rate home equity loans, and maybe — just maybe — a coming recession.

Let’s hold off on the recession talk for a moment, and start with the underlying good news on why bond rates are rising. Short answer: The economy is expanding quite fast, so fast that the Federal Reserve is working hard to make sure inflation doesn’t get out of control.

The Fed’s job is to keep economic growth in the goldilocks zone: not too fast, not too slow. And in our current growth climate, with unemployment near 50-year lows, Fed members have begun tapping the brakes.

By raising just one very short-term rate — the amount banks pay each other for overnight loans —

the Fed can actually have a broad impact on the economy, putting upward pressure on all kinds of other interest rates, from those on revolving credit card debt to those for CDs at the bank.

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This chain reaction of rising interest rates dampens economic activity. Partly, that’s because saving money suddenly becomes a better deal — since you can get better returns on bonds and certificates of deposit. But just as important, higher rates make it hard for individuals and businesses to borrow money for everything from building new facilities to making home improvements — so they delay some of that spending.

Five times over the past 18 months, the Federal Reserve has voted to raise its benchmark rate, and looking ahead, members of the rate-setting Open Market Committee expect another five increases before the end of 2019. Those moves —

both real and promised — are the big reason bond prices have been rising.

But there’s one more wrinkle: While the Fed’s rate increases affect virtually all interest rates across the economy, the effects aren’t always equal. And recent hikes seem to be having a much larger impact on short-term bonds than on long-term ones.

Payouts on 2-year Treasurys have nearly doubled since last fall, rising to nearly 2.5 percent, from 1.27 percent. That’s a much bigger change than you see with the 10-year note, which has risen less than 1 percentage point over that same period. After touching 3 percent, the 10-year yield eased back to abut 2.98 percent.

Little by little, the yield on 2-year Treasurys is actually catching up with the yield on the 10-year ones. And that can be a sign of a coming recession, particularly if the two ever cross.

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In normal economic times, long-term bonds (like the 10-year) are expected to pay higher interest rates, to compensate investors for the fact that their money is going to be tied up for an extended period. When this doesn’t happen, and long-term rates fall below short-term ones, it can be a sign of pessimism about the future, suggesting investors actually want their money tied up, to keep it safe from a coming crash.

That’s the worst-case scenario. But in the meantime, look on the bright side. Rising bond rates make this the best time in years for risk-averse savers. And if you’re looking for a cheap mortgage, you might consider acting before the rates go even higher.


Evan Horowitz digs through data to find information that illuminates the policy issues facing Massachusetts and the United States. He can be reached at evan.horowitz@globe.com. Follow him on Twitter @GlobeHorowitz.