Stock market investors suddenly seem convinced that rising interest rates could kill the bull market and perhaps the economic expansion. That may turn out to be true. The problem is that they might be watching the wrong rate curve.
Stock market investors appear most focused on the Treasury yield curve. That played a large part in Tuesday’s 799-point drop in the Dow Jones Industrial Average. Longer-term yields, like those on five-year notes or 10-year bonds, tend to be higher than those on two-or three-year notes.
The difference between those rates creates the yield curve. Investors need to be compensated for the risk of holding long-term bonds, so those yields are usually higher. The curve is also a traditional indicator of economic expectations. Higher expected future interest rates suggest that investors think there will be higher levels of economic activity. But right now, the opposite is happening. The yields on two-and three-year Treasuries are either about the same or higher than the one on the five-year note. An inverted yield curve is often a sign of an impending downturn.