Rising Treasury yields tend to undermine the performance of stocks, with higher rates on government debt offering a more attractive opportunity for investors. Or so the convention thinking goes.
There’s a bit more going on for investors to consider right now, though, and one of them is the so-called AI trade, or plays which benefit from the emergence of artificial-intelligence technology and Nvidia Corp.’s
NVDA,
role as the leader of that movement.
According to Edward Moya, senior market analyst for the Americas at OANDA Corp. in New York, AI trades have the potential to overshadow the impact of higher yields going forward, and may allow stocks to make a run for record highs after the Federal Reserve’s Sept. 20 policy decision because that’s when “policy makers will be in a better position of signaling they’re done with raising rates.”
Moya’s view captures a period beyond Thursday’s up-and-down session. All three major stock indexes initially rallied from the open in reaction to another round of record earnings and blowout forecasts from Nvidia on Wednesday, even though 3-month
BX:TMUBMUSD03M
through 30-year yields
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were all higher. As trading wore on, however, the Nvidia-spawned euphoria faded as higher yields and a rising dollar
DXY
put pressure on equities, with all three major indexes ending sharply lower. Nonetheless, Moya stands by what he sees as a bullish case that can still be made for stocks in the months ahead.
Read: Can Nvidia keep growing this quickly? Here’s what Wall Street thinks.
Thursday’s rise in yields provided “a good opportunity” for stock investors to engage in profit-taking, Moya said via phone after all three major stock indexes turned lower. Overall, however, “we are still in the very early stages of the AI trade and when the dust settles from all the noise we’ve had this week and full trading volumes return, the AI trade and Nvidia will lead the stock market higher.”
Unlike other observers — who see the potential for Fed Chairman Jerome Powell to unnerve stock investors on Friday with his Jackson Hole speech — Moya said Wednesday’s round of weak readings from purchasing managers indexes in the U.S., the eurozone, and the U.K. “could be a game changer for him that warrants some dovish hints.”
“It’s pretty clear that we don’t have robust global growth prospects right now,” the analyst said. “The Fed should not say ‘mission accomplished’ with fighting inflation, but that we are close to it. That’s the message that needs to be sent.”
Read: Will Powell crush stocks again during Friday’s Jackson Hole speech? Here’s one reason investors shouldn’t worry.
Remarks made by a pair of Fed officials on Thursday could be interpreted as helping to support Moya’s case. Philadelphia Fed President Patrick Harker said in a CNBC interview that officials have probably hiked interest rates by enough to bring inflation down. Meanwhile, Boston Fed President Susan Collins told MarketWatch that she can see scenarios in which policy makers might hold rates close to where they are now.
Yields on 10-
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and 30-year Treasurys reached their highest closing levels since 2007 and 2011 on Monday, as traders factored in a stronger-than-expected U.S. economy prior to Wednesday’s PMI readings. Those rates slipped on Tuesday and Wednesday, only to bounce back again on Thursday amid a renewed selloff of U.S. government debt ahead of Friday’s Jackson Hole speech.
Dow industrials
DJIA
and the S&P 500
SPX
are off their record closes reached in January 2022 by 7.3% and 8.8%, respectively, according to Thursday figures from Dow Jones Market Data. The Nasdaq Composite
COMP
is down by 16% from its record close in November 2021. Nvidia shares finished 0.1% higher on Thursday at $471.74, just short of a record closing high.
The current period of higher interest rates and elevated inflation has defied expectations in a number of ways. The U.S. economy has managed to withstand more than five full percentage points of interest rate hikes since March 2022 better than many expected. American savers are getting a boost from higher rates, turning into another source of strength for the economy. And the stock market is still up for the year, even though 10- and 30-year Treasury yields are not far from their highest levels in more than 12 years.
History shows that rising yields don’t always undermine the stock market’s performance. Two weeks ago, Ed Clissold, chief U.S. strategist, and Thanh Nguyen, senior quantitative analyst, for Ned Davis Research found that higher yields can be consistent with risk-on sentiment in equities, based on data stretching back more than 40 years — well before AI trades were ever a part of the equation.
See also: Can the stock-market rally survive rising Treasury yields? Here’s what history says.
In a note distributed on Thursday, Clissold and Nguyen said that the recent rise in the 10-year yield, which is up almost a full percentage point since April, hasn’t been “violent” enough to completely derail the stock market, at least by historical standards. While the speed at which yields rise or fall tends to affect the S&P 500, the moves in Treasury yields haven’t been as extreme as what was seen in 2022, 2015, 2012, 2010 and 2008, they wrote.
One intermediate-term implication of higher rates is that “financial markets are pricing in a stronger economy,” they wrote. “Year-to-date through July, the message had been bullish for stocks because it was removing the consensus call for a recession in 2023.”
The message has since flipped to one in which “a stronger economy could mean the Fed could keep its target rate higher for longer,” they said. Even so, “the short-term risk to the stock market may be minor because the economy is accelerating, earnings growth is exceeding expectations, and the two-year yield, which is the most sensitive part of the curve to changes in Fed policy, has not risen sharply.”
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