A calm session followed by a sudden slump. That sums up Wednesday's trading in the US. After opening close to equilibrium, the indices fell back, with the S&P 500 ending the session down 1.61%.
Auctions to watch closely
The reason behind this decline was a US Treasury auction—$16bn in 20-year bonds—where demand was weak.
Usually, 20-year issues are not closely followed because this maturity is unpopular with investors, who prefer 10-year or 30-year bonds. There is therefore little liquidity in these bonds. Issues with this maturity were even abandoned in 1986, before being reintroduced in 2020 by Steven Mnuchin, Secretary of the Treasury during Donald Trump's first term.
On Wednesday, for the first time since 2020, the rate on this issue exceeded 5%. In the wake of this, long-term rates rose and equities took a hit.
Against a backdrop of high US debt, on the one hand, and lower appetite for US assets, on the other, Treasury issues are now being closely monitored by investors. This is something of a moment of glory for bond managers, and concepts such as tail (which measures the difference between average prices and the lowest accepted prices) and bid to cover (the ratio measuring the relationship between supply and demand for an issue) are set to become part of our everyday vocabulary.
A pivotal level
Beyond the issue of issuance alone, we are now in a context where movements in the bond markets are setting the tone, particularly for equities.
From this perspective, we are entering a danger zone for long-term rates. MarketScreener's macro research teams have conducted a study to assess the average performance of the S&P 500 according to interest rate levels. The study covers the period beginning in October 2022, when the US 10-year yield rose above 4% again. Over this period, we calculated the performance of the S&P 500 according to the threshold above which the 10-year yield stands.
Source: MarketScreener macro research
What we see is that 4.5% is the pivot point. Since October 2022, on the 101 days when the 10-year yield was above this level, the average annualized return on the S&P 500 was negative.
However, it should be remembered that before the 2008 financial crisis, the US 10-year yield was above this threshold and even well above it, and this did not prevent equities from performing well. The period of low interest rates that we experienced for around 15 years is more of an anomaly than the norm.
The problem and the solution
The conclusion from all this is that equities prefer low rates in absolute terms but can live with higher rates. What matters is the direction of travel and the speed of movement. Because what is very bad for risky assets is when rates rise sharply.
This pattern notably occurs when there are high concerns about a country's debt level. Or more specifically, about the trajectory of debt, as absolute levels are already very high for many countries. This is what we saw in the UK in 2022. At the time, Liz Truss proposed a plan involving significant unfunded tax cuts. Rates soared, forcing the Bank of England to intervene and the Prime Minister to resign.
This episode echoes the current debates in the US Congress, where the House has just adopted Donald Trump's tax cut plans. For a country like the US, which has such a high level of debt and depends, in part, on the rest of the world to finance it, we must be careful not to do anything too rash, at the risk of being punished by the markets. This is exactly what we saw with the announcement of reciprocal tariffs in early April. The rate hike forced Donald Trump to back down and announce a 90-day pause.
For the remainder of his term, it is highly likely that the bond market will be both the problem and the solution. The problem because that is where market turbulence will come from. And the solution because bond market movements will force Donald Trump to return to more reasonable positions, whether in terms of trade or on fiscal policy.
The bond market will therefore be the market to watch for investors. To use a phrase commonly used in the US: "the bond market is in the driver's seat."
