Bond yields got a fresh impetus on Wednesday from US, lawmakers' deal on the budget, with 10-year USA yields back up to 2.84 percent, near Monday's four-year peak of 2.885 percent.
Stocks in world indexes fell again on Thursday, with major US indexes dropping more than 3 percent in late afternoon trade after USA bond yields earlier crept back up towards four-year highs. The Dow surged 567 points on Tuesday, but a 381-point rally vanished on Wednesday after bond yields crept higher. The bond market is a decent indicator of fears about inflation.
"The bond market has definitely got the stock market's attention", said Ryan Detrick, senior market strategist at LPL Financial. The debt sold at less than 1 basis point higher than where the bonds traded before the auction. That's a big spike from just 2.65% during the panic selling Monday afternoon. Volatility in equities, at the same time, has at times added to a bid to hold low risk USA government debt.
For a market that hadn't fallen 3 percent from any high in more than a year, the week's action was enough to rattle even the biggest equity bulls.
"Inflation can really crimp multiples and that's something that greatly affects stocks, and then interest rates, price in the attractiveness of alternatives and that can affect it". Traders are also facing the prospect of Fed rate hikes, which could cool growth.
Dudley, who called the market slump "small potatoes", said the "jury is still out" on the number of rate hikes.
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To some extent, longer-dated USA treasury bond yields have been playing catch up with the front-end of the U.S. treasury curve, as shorter-dated yields had already seen a meaningful rise in the fourth quarter of 2017.
Washington is putting more pressure on rates.
The Senate and the House were both expected to vote on the deal on Thursday. The compromise, coupled with Republican tax cuts, could lift the federal budget deficit to $1.07 trillion in fiscal 2019, according to Bank of America estimates. The fragile rebound lifted the market a bit, and the Dow and S&P 500 are now about 8% off their from all-time highs. The country has resumed its Qualified Domestic Limited Partnership plan after a two-year halt, granting licenses to about a dozen global money managers that can raise funds in China for overseas investments, Reuters reported on Thursday, citing people it didn't identify.
The fear now is that alongside the economic boost President Donald Trump's tax cut plans may deliver, higher deficit spending could overheat the already strong US economy and accelerate inflation to levels not seen in over a decade.
The dread that gripped equity markets earlier in the week re-emerged Thursday as US stocks plunged into a correction on concern that rising interest rates will drag down economic growth.
"The U.S. economy is on solid foundation", said ClearBridge's Schulze.