(Bloomberg View) -- To suppose that equities and debt live in different worlds is a mistake of the first order. These two markets are joined at the hip and sometimes, such as on Tuesday, one market can move the other more than it is moved.
Tuesday began with questionable headlines suggesting that a bond market rout was in progress. Where this oft repeated notion comes from, which in my opinion is far from the truth, is an open question. The price of the benchmark 10-year Treasury note was down about 9/32 at one point, which hardly represents a shellacking.
Yet, the equities market seemed to take the bait. The Dow Jones Industrial Average closed down 362 points,which was no fun for most investors. Now, there are calls that the "Day of Reckoning" has arrived, but I'm not a buyer of "End of the World" scenarios. For more than 40 years on Wall Street I have watched this type of gibberish being spouted in the media by people that are angling for stardom by making absurd projections. These people come and go; another "Nanosecond Nellie" at bat.
The bond market does influence the economy and, by extension, the equity market. As the cost of borrowing increases, the real estate market, corporate borrowings and the overall economy can stall. Profit margins shrink as corporate debt becomes more expensive. This results, generally, into lower equity prices as earnings get squeezed.
Treasury 10-year yields have risen from 2.06 percent in early September to as high as 2.73 percent this week. Although that seems scary, one must consider the starting point when examining this move. Yields of 2 percent or, put another way, 2 percent borrowing costs, do not eat into corporate profits like 5 percent yields. It is "profit margin," remember, and the margin is affected far less when rates are this low.
The situation looks more benign when you pull back the covers. Yields as measured by the Bloomberg Barclays (LON:BARC) Corporate Bond Index have risen from 3.05 percent in early September to 3.45 percent currently, which is a smaller increase than seen in Treasuries.
This is telling in two ways. First, it shows the tremendous compression of risk assets to their Treasury benchmarks as demand has kept up for any sort of yield. Second, it shows that the increased costs of corporate borrowing is nowhere near what you might expect if you looked at just the Treasury market. This is notable because it means that not only are borrowing costs less than what you might expect, but that corporate profit margins are not going to be impacted as significantly as many predict.
Even if the 10-year Treasury yield, which is currently trading in a range of 2.63 percent to 2.72 percent, rose to 3 percent it shouldn't ring any alarm bells.
There is some genuine concern about increased borrowing by the U.S. Treasury, though that has been mitigated recently. The U.S. said Monday it expects to borrow $441 billion in the first quarter, $71 billion less than previously estimated. The new forecast includes an end-of-quarter cash balance estimate of $210 billion. During the second quarter, the Treasury expects to borrow $176 billion in net marketable debt with a cash balance of $360 billion. To put that in perspective, the Treasury borrowed $282 billion in net marketable debt last quarter and ended with a cash balance of $229 billion. The government had estimated borrowing of $275 billion for the quarter.
One of the main questions now is what incoming Federal Reserve Chairman Jerome Powell might do at the central bank. If he slows -- or even stops -- the pace of interest-rate increases, then we could see lower bond yields. Then there is the question of just what the tax cuts might do to tax receipts, as the trade-off in lower taxes may be more than off-set by higher revenues that produce more taxes. Finally, there is the question of whether risk assets will continue to tighten against their benchmarks as the "Pixie Dust" money created by the world's central banks hunt for yield.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mark Grant is a managing director and chief global strategist at the investment bank B. Riley FBR Inc.