What's going on?
An accelerating selloff in bonds precipitated another 4% selloff of US stocks on Thursday, leaving them down more than 10% from their recent highs.
What does this mean?
There’s a lot going on in the wacky world of interest rates right now. For one, better economic growth and a higher oil price have led investors to expect inflation to increase (more demand for products leads to higher prices). When inflation goes up, bonds – which pay a fixed amount of interest – tend to go down in value, because the cash they pay out becomes worth less (i.e. it buys less stuff).
At the same time, major central banks are either buying fewer bonds (e.g. the European Central Bank) or, essentially, selling bonds (e.g. the US Federal Reserve). Some big central banks are also increasing their target interest rates, which makes bonds even less attractive – if an investor can buy a bond in the future that pays a higher interest rate, that investor will likely sell their current ones.
Why should I care?
For you personally: This is a potential problem for your portfolio.
Most standard investment portfolios consist of stocks and bonds. In recent years, most have performed very well as stocks and bonds have risen together. As central banks bought bonds, pushing up their prices, stocks became relatively more attractive, leading investors to buy stocks. Now that bonds are going down in price, investors are aggressively selling stocks too.
For markets: It’s not all bad news, though…
Stocks benefit from better economic growth in ways that bonds don’t: it boosts companies’ earnings, which is positive for stock prices. However, those same factors also make central banks confident enough to remove their support. Just like a good old-fashioned tug of war, investors can expect to see some back and forth between these opposing forces as 2018 progresses.