S&P 500 heads for worst month since 2022 as bond yields jump on inflation fears

The U.S. stock market’s bull run has hit a rough patch, as bond yields spiked this month on fears that a robust economy is helping to keep inflationary pressures alive.

The S&P 500 SPX is on pace for its biggest monthly drop since December 2022, with April’s pullback erasing about half the gains the U.S. stock market had booked this year by the end of March. The index has slumped 5.5% this month through Friday, lowering its climb in 2024 to 4.1%.

Still, the S&P 500 is just 5.5% from its record closing peak on March 28. Equities investors got it right this year that economic growth remained strong in the U.S., but the problem now is that the view is already priced into stocks — and that yields in bond market were left to catch up, according to Bob Elliott, chief executive officer and chief investment officer of Unlimited Funds.

This year’s rise in yields in the Treasury bond market accelerated in April, rattling U.S. stocks. But as Elliott sees it, long-term Treasury rates may need to climb even higher to cool demand in the economy, before the Federal Reserve gains enough confidence that inflation is falling durably towards its 2% target.

“Financial conditions, pretty much any way you slice it, are easy today,” Elliott said in a phone interview. “All indications are this first-quarter GDP number is going to be pretty strong.”

This coming week, on April 25, investors will see an estimate from the Bureau of Economic Analysis on U.S. gross domestic product growth in the first three months of 2024. So far, the economy has been resilient despite the Fed’s tightening monetary policy to lower inflation.

The Atlanta Fed’s GDPNow tracker estimated as recently as April 16 that real gross domestic product expanded at an annual rate of 2.9% during the first quarter. That is “its highest reading in over a month,” said DataTrek Research co-founder Nicholas Colas, in a note emailed Friday.

Just as the initial jobless claims data show no signs of the U.S. labor market weakening, “GDPNow suggests economic growth remains stable,” said Colas. “The American economy seems to have ended” the first quarter on “an upbeat note.”

Yardeni Research also pointed to jobless claims as evidence of a strong labor market.

“Initial unemployment claims is the best high-frequency indicator of the jobs market,” Yardeni wrote in a note dated April 18. “It is signaling that the unemployment rate might have remained below 4.0% during April for the 27th month in a row!”

With the U.S. unemployment rate at a historically low level, consumers keep spending, adding to concerns about inflation.

Average hourly earnings, particularly for lower-income cohorts, have been increasing, and even if nominal wage growth has recently slowed, it remains “pretty strong,” said Elliott. People in upper-income brackets may have seen a smaller rise in wages, but their exposure to higher asset prices, including stocks, supports spending, he said.

The U.S. stock market notched a series of record highs this year, and remains up despite long-term Treasury yields in April rising to the highest levels since November.

On Friday, the yield on the 10-year Treasury note BX:TMUBMUSD10Y ended at 4.613% based on 3 p.m. Eastern time levels, according to Dow Jones Market Data. The 10-year rate has jumped about 75 basis points this year, including about 42 basis points in April.

Although the S&P 500 SPX fell Friday to 4,967, that level remains far above the October low it reached after the yield on 10-year Treasury note climbed that month as high as about 5%.

During October the S&P 500 closed as low as 4,117. Stock prices at that level were insufficient to slow the economy meaningfully, said Elliott, and they’re now up more than 20% since then even after April’s slump.

“We probably need a pretty material rise” in long-term rates and “for a much longer period of time,” he said. Elliott estimated that the yield on the 10-year Treasury note may need to climb to between 5% and 5.5% for an extended period of time, maybe for about a year, to sufficiently slow the economy to bring inflation down sustainably to the Fed’s 2% target.

Meanwhile, “we got a rise in commodity prices, which is problematic for the Fed,” he said, pointing to a rise in prices of industrial metals such as copper, precious metals including silver and gold, some agricultural commodities and oil.

Oil CL00, +0.17% is “a meaningful input basically to all economic activity,” said Elliott. “We’re already seeing prices at the pump rise” in terms of the cost of gasoline paid by consumers, he said.

A reading on March inflation from the Fed’s preferred gauge, the personal-consumption-expenditures price index, is due out this coming week on April 26.

Traders in the federal-funds futures market are betting that the Fed may begin lowering its benchmark interest rate in September, potentially by a quarter percentage point to a range of 5% to 5.25%, according to the CME FedWatch Tool, at last check. They’re anticipating maybe just one or two rate cuts in 2024, far fewer than at the start of January.

“The macroeconomic data would align with the Fed not doing much this year,” said Elliott. And it’s not that much different from just a few months ago, when traders were pricing in six or seven rate cuts by the Fed, he said.

Meanwhile, the two-year Treasury yield BX:TMUBMUSD02Y trading at about 5% implies just one cut in the fed-funds rate, by a quarter percentage point, over the next 12 months, according to the Yardeni note.

“The bar has always been high” for Fed interest rate cuts, said Kevin Gordon, senior investment strategist at Charles Schwab, in a phone interview. “It’s going to stay high until you either get strong disinflationary pressure,” he said, or weakness in the labor market, which would be “a much more negative scenario for risk assets.”

U.S. stocks ended Friday with the S&P 500 falling for a third straight week as technology stocks dropped sharply. The tech-heavy Nasdaq Composite COMP saw four straight weeks of losses, its longest losing streak since December 2022, according to Dow Jones Market Data.