Wednesday, October 20, 2021

EXPLAINER: Why rising rates are unsettling Wall Street

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NEW YORK (AP) – Yes, it is possible to have too many good things, and that is exactly why stock markets around the world are so volatile.

Optimism for an economic recovery is soaring after a year of coronavirus-induced misery. But expectations of stronger growth – plus the higher inflation that might come with it – are pushing interest rates up, forcing investors to reconsider how they value stocks, bonds and more. all other investments.

When trying to determine the value of anything from Apple stock to an unwanted bond, the financial world begins by comparing it to a US Treasury bond, which the government uses to borrow money. For years, yields have been extremely low for Treasurys, meaning investors have gained very little interest in owning them. This in turn helped to make stocks and other investments more attractive, driving up their prices. But when Treasury yields rise, the downward pressure on the prices of other investments also increases.

All eyes have been on the yield on the 10-year Treasury bill, which has climbed above 1.50% this week after starting the year around 0.90%. Here’s a look at why the move rocked the financial world, including the worst week for the Nasdaq composite since October:

WHY ARE TREASURY RETURNS INCREASING?

Part of the reason is rising inflation expectations, perhaps a bond investor’s worst enemy. Inflation means that future bond payments won’t buy as many bananas, college tuition minutes, or anything else that goes up in price. Bond prices therefore tend to fall when inflation expectations rise, which in turn pushes their yields up.

T-bill yields also often follow expectations of a stronger economy, which are on the rise. When the economy is healthy, investors feel less of a need to own treasury bills, which are considered the safest investment possible.

WHY DO FALLING BOND PRICES MEAN RISING RETURNS?

Let’s say I bought a bond for $ 100 that pays 1% interest, but I’m worried about inflation rising and I don’t want to get stuck with it. I’ll sell it to you for $ 90. You obtain more a return on investment of 1%, because the regular payments from the bond will always be the same amount as when I owned it.

WHY ARE EXPECTATIONS FOR INFLATION AND GROWTH INCREASING?

It is hoped that the coronavirus vaccines will allow savings to vibrate this year, as people will feel comfortable returning to stores, businesses will reopen, and workers will find jobs. The International Monetary Fund expects the global economy to grow 5.5% this year after falling 3.5% last year.

A stronger economy often coincides with higher inflation, although it has generally been trending downward for decades. Congress is also set to inject an additional $ 1.9 trillion into the U.S. economy, which could further boost growth and inflation.

WHY DO PRICES AFFECT THE PRICES OF SHARES?

When trying to price a stock, investors often look at two things: how much money the company will generate and how much to pay for every dollar of that cash. When interest rates are low and bonds pay little, investors are willing to pay more for this second part. Consider a stock like Apple or some other Big Tech the business, which will likely continue to generate significant cash flow for many years to come. It is more it’s worth the long wait if a 10-year Treasury pays less in the interim.

AND NOW THAT THE RATES ARE ON THE RISE?

The recent surge in yields is forcing investors to reduce what they are willing to spend for every dollar in future company profits. Stocks with the highest prices relative to earnings are hit hard, as are stocks that bid for their long overdue earnings …

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