The sudden sell-off can be explained in large part by looking at the bond market. Simply put, stocks are sinking as Treasury rates spike.
1. Interest rates are rising
Over the past decade, Wall Street became addicted to easy money. Unbelievably low interest rates from the Federal Reserve encouraged investors to take risk by piling into stocks. Lower borrowing costs meant higher corporate profits.
That trend is now reversing, albeit for mostly good reasons: The American economy is really strong, and the Fed is raising rates to keep inflation in check and make sure the economy doesn’t overheat.
As interest rates rise, investors have been getting out of bonds, driving down their price and driving up their yields. Investors are worried that their investments will be less profitable over time if inflation picks up.
The 10-year Treasury yield hit 3.24% on Wednesday for the first time in seven years. That’s an about-face from 2.85% at the end of August.
2. The Fed is sticking to its guns
Stocks tend to slump after rapid rate spikes. Suddenly, stocks are getting competition from boring bonds.
Fed chief Jerome Powell reinforced these worries last week by suggesting the Fed has a “long way” to go in its quest to return rates to normal levels. Powell said rates are not close to “neutral,” the level where the Fed is neither hitting the gas nor the brakes on the economy.
In other words, it’s full steam ahead for the Fed. Some investors — and even President Donald Trump — worry the Fed could be moving too quickly.
“I think the Fed is making a mistake,” Trump told reporters in Pennsylvania on Wednesday. “They’re so tight. I think the Fed has gone crazy.”
3. Investors are worried about debt and China
Rising rates may already be pinching parts of the US economy, particularly housing and the auto market.
Rates are also going up because the US government is selling more Treasuries to pay for the soaring federal deficit. Washington is borrowing heavily to pay for the corporate tax cut and a surge of government spending.
The good news is that Corporate America is minting money right now. Third-quarter S&P 500 earnings are projected to soar by 20%. Strong profits could very well ease investor anxiety. That’s what happened earlier this year when Treasury rates spiked, briefly spooking the market before cooler heads prevailed.
And then there’s the trade war between China and the United States — the world’s two largest economies.