All eyes are on the U.S. 10-year Treasury yield on Monday as it could imminently hit the 3 percent threshold — a level deemed particularly worrying by investors.
“The 3 percent level is a big psychological point for investors and has gained huge focus,” Roger Jones, head of equities at London and Capital, told CNBC via email.
Indeed, the 10-year Treasury yield was at 2.9882 percent at about 6:20 a.m. ET, inching closer to 3 percent — a level not seen since 2014.
Subsequently, yields have mostly followed a downward path on the back of support from central banks, which tapped into bond markets in the wake of the global financial crisis in 2008 to boost their economies. But their prolonged intervention has made investors accustomed to their support and to the guarantee that central banks would be there in case things turned badly — leading to higher equity investing, when investors buy shares of companies.
As the 10-year yield stops following that downward trend, it raises concerns that the positive outlook for equity investment is about to end.
“It is not the move towards 3 percent Treasury yields which is unusual, but the historically low level of yields we’ve seen in recent years, reflecting the long-lasting scars of the financial crisis,” Seamus Mac Gorain, fixed income portfolio manager at J.P. Morgan Asset Management, told CNBC via email.
“The now healthier global economy justifies these higher yields. We expect 10-year Treasuries to end the year between 3 and 3.5 percent,” he added.
But, above all, the 3 percent level has a “psychological” aspect that makes markets anxious. The 10-year note is used as a benchmark for many financial instruments, including mortgages and as a barometer of investor confidence.
“Three percent is a psychological level… Rates were never able to break that trend-line durably event since the early ’80s,” Francesco Filia, chief executive of Fasanara Capital, told CNBC via email. “To break it neatly and clearly would reignite fears that rates rise is durable.”
The problem of a long period of rates increases is the implication for those making investments. Higher rates mean that companies will have higher costs when borrowing money, but they also mean that their debts become more expensive. As a result, companies will have less room to increase salaries, to invest in their business and to give returns to shareholders.
“Higher rates are unloved by equities,” Filia said, adding that, ultimately, higher rates also increase the risk of defaults.
So higher rates not only make equities less attractive, but they also signal that the economy is, or could be, at risk. If companies see their margins squeezed, they might be forced to pay less to employees, even lay-off people.
The particular effect of higher rates on mortgages also lowers people’s ability to spend elsewhere. Therefore, society is no longer able to spend the way it has been, and this ultimately kicks off an economic crisis.