The 5% problem

Amid a tech selloff, an oil crisis, and the resurgence of war in the Middle East, you might wonder why you should pay attention to boring old bonds. But right now, the bond market is flashing a serious warning sign investors need to pay attention to.

The 30-year Treasury yield has traded above 5% for 27 days this year, the longest stretch since the financial crisis kicked off back in 2007. What that means is that the interest rate the US government has to pay to borrow money for the next 30 years is staying high (keep in mind, bond prices and yields move inversely).

That’s not exactly a vote of confidence for the US from bond investors, and it signals that many are concerned about the US’ fiscal sustainability. It’s easy to understand why: despite inflation decelerating in June, prices are still rising at a pace above the Fed’s 2% target. Oil prices spiked again today to their highest in six weeks, with reignited conflict between the US and Iran promising to keep pushing inflation higher.

On top of fear that inflation will stay higher for longer, investors are still concerned about the ballooning US debt pile. Another factor putting pressure on the Treasury market is that bond investors have a new source of competition: Large tech companies like Microsoft, Apple, and Amazon are issuing plenty of long-dated corporate bonds to fund their AI pipedreams.

Fixed income, broken economy

While 5% is a largely psychological number, if history is any indication, it’s not great news for equities.

When investors can get a 5% risk-free yield from bonds, there’s less reason for them to wager on similar returns from stocks. On top of that, higher borrowing costs weigh on businesses, which could in turn hurt share prices, underscoring the safety of bonds.

There’s also the issue of mortgage rates, which tend to follow Treasuries (specifically the 10-year note). When mortgage rates rise, it makes it harder for people to buy homes, weighing on homebuilding stocks, since investors surmise that higher mortgage rates will equal fewer new homes being built.

However, according to Michael Darda, the chief economist at Roth Capital Partners, that’s counterintuitively a good thing for homebuilder stocks. He says that investors have been too pessimistic about homebuilders, arguing that buying these stocks cheap has been a great investment over the past few years, and will likely continue to pay out in the long term.

Any headline that compares the current market to 2007 is understandably spooky—but there are still opportunities beyond Treasuries if you know where to look.—LB