The Dow Jones plummeted by 430.97 points, a 1.29% drop, at closing bell as both the Nasdaq and S&P 500 indices suffered even worse losses.
The initiating factor in the mass selloffs was the 10-year and 30-year Treasury bonds hitting their highest levels since August 2007, continuing a trend that began on Monday of rapidly increasing yields. Late on Tuesday morning, it was at 4.77% - even higher than at the opening bell.
On Friday, the Federal Reserve released new projections indicating that interest rates will be higher for longer than expected in order to ensure inflation slows to 2%. Higher interest rates are beneficial for investors. However, the fact that the Treasury depleted its cash reserves during the debt ceiling crisis earlier this year means it’s now hungry for more, and has increased the number of bonds available to buy.
“Inflation continues to be too high, and I expect it will likely be appropriate for the Committee to raise rates further and hold them at a restrictive level for some time to return inflation to our 2% goal in a timely way,” Fed Governor Michelle Bowman said on Monday.
Remarkably, the yield on the 2-year Treasury bond has remained above that of the 10-year bond, sitting at 5.12% on Tuesday morning. When the short-term bond’s yield is higher than the long-term bond, it’s called an inverted yield curve - a telltale sign that investors expect the economy to tank soon. Bizarrely, for nearly all of the 18-month period since the Fed started raising interest rates in the spring of 2022, the yield curve has been inverted.
However, if interest rates stay high for too long, it might smother business expansion alongside the inflation, triggering layoffs, a decline in business, and ultimately a recession. While inflation is lower than it was and job numbers have continued to increase, unemployment in the US has begun to tick higher and there are signs the economy may be beginning to slow. The recent downgrading of the US government’s credit rating in August, an effect of the crisis in confidence caused by the debt ceiling showdown, which nearly caused a default, is also likely to hurt future international investment.