Markets Could Be Spooked By A Major Psychological Level In Bond Yields

Analysts are predicting that the benchmark 10-year Treasury yield is heading towards a key level that could give stock investors a very bad scare in the near future.

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During recent sessions, the yield on the 10-year Treasury note has broken through resistance and is now just a hair shy of the crucial 4% level. After struggling in January, yields have been rising through the month of February, which is the opposite of price movement. During the late morning hours of trading, the yield for the bond was 3.94%.

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Stocks might experience more volatility if the rate is raised to 4%.

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“There is no doubt that the market likes when yields come in when they are high. Whenever they rally, the equity market does not like that at all. I believe that there is a strong inverse relationship between yields and the stock market,” according to Katie Stockton, founder of Fairlead Strategies. The fact that yields were pulling back in January was one reason why we had an outperformance in the tech sector in January."

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It is particularly important to keep an eye on the 10-year because stocks, in particular growth stocks as well as technology companies, tend to respond to its movements. There are other reasons why it is important to an investor's psyche as well. Mortgage rates are one of the main factors influencing consumer and business loans as well as other types of credit.

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Stockton explained that with the short-term breakout, the indicators are now pointing toward higher levels, and we are now seeing a shift in our intermediate-term trend gauges. “As a result of this, 4% appears to be a psychological level, not a resistance level, but a psychological level nonetheless… It impacts people for no purpose other than it's a round number. I believe it is a matter of perception. Human nature is such that they will hear that 4 and it will sound different to them than it does to others."

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The founder and partner of T3Live.com, Scott Redler, said he expects to see stock prices descend when the yield crosses the 4% mark as a result of computer-related selling.

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It is imperative that you look at the 10-year chart. "You've got to check out TLT," he said. IShares TLT is an ETF that invests in 20+ year Treasury bonds.

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“There is a tape that is driven by yields. The street has come to the realization that rates are going to stay higher for a longer period of time."

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In Stockton's view, the stock market sell-off accelerated when the 10-year crossed the resistance level at 3.82% on Feb. 16, resulting in a breakout in the yield and breakout in the yield. It is now expected that the 10-year will rise above 4% and reach its next target of 4.34%, which is the high from October of last year.

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On the 10-year yield chart, Stockton predicted that the next big level would be approximately 5.25%, a level that has been a resistance level since 2006, once the yield reached the October high. Having said that, Stockton said that she is no longer calling for the yield to reach that level in the near future.

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“As a result of our analysis, we are seeing 4.34 as the potential upper bound of a trading range,” she said.

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In regards to stocks, the market could continue to be rocky as it adjusts to the upward move in rates over the coming months. During times of rising borrowing costs, shares of technology and growth companies are particularly vulnerable, since they are priced on future earnings and a higher cost of borrowing causes those earnings to appear less valuable.

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“Since February 16, when the S&P fell below 4,100, we have been in an action sequence to the downside [in stocks]. This was your active signal to reduce risk," said Redler, referring to the active signal. “Since then, the market has experienced a controlled pullback, but it hasn't collapsed by any means.”