- Bond yields are back in focus this week as the Fed gets kicks off its policy meeting.
- The 10-year is close a level that could put pressure on stock prices, Morgan Stanley said.
- Long-term bond yields peaked above 5% last October. The 10-year yield was about 3.34% Monday.
The stock market has sidestepped concerns of higher bond yields so far this year as investors have ridden the artificial intelligence hype train and enjoyed a strong earnings season, but Treasurys are nearing a level that could put pressure on stocks again, Morgan Stanley says.
Strategists led by Michael Wilson said in a note on Monday that the 4.35% mark for the 10-year US Treasury has been viewed as "an important technical level" to signal the potential for higher rate sensitivity for stocks.
The key bond yield was just one basis point below that level on Monday afternoon, hovering around 4.34%, and yields could be volatile this week as the US central bank delivers its latest messaging on the direction of monetary policy.
"We think a key question for this week is whether the direction of rates will begin to matter more for the valuations of large cap equities," the analysts wrote in the note.
Yields on long-term bonds peaked last October, coinciding with a low in the stock market. The latest equity rally kicked off with the Treasury indicating less new issuance than markets had expected and the Fed's nod to easing monetary policy at its final meeting of the year
"This surprise occurred at a time when a large part of the bond community was short duration, which in addition to the Fed's 4Q policy shift, helped fuel a squeeze into year end," the note said, adding that multiple expansion driven by falling bond yields accounted for almost all of the stock market's returns during this period.
Still, the bank acknowledged that while rising bond yields are in focus again, investors this year appear to have largely begun to look past the influence of monetary policy in favor of corporate earnings growth and enthusiasm for AI.
"From an equity standpoint, the rise in rates this year has not had the typical effect on valuations—i.e., P/E multiples have remained elevated in the face of rising rates," the note added.
The strategists said they're eyeing the 10-year Treasury yield's 200-day moving average as the Fed kicks off its meeting this week.
"Should rates decisively fall back below the 200-day moving average, it could serve as support for equity valuations to remain elevated," they wrote.