Dow drops 400 points as bond yields creep higher

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Outside of the financial crisis, they have moved in opposing directions. The Fed kept rates near record lows during most of the Obama administration and the federal debt nearly doubled to about $20 trillion.

USA consumer prices rose 2.1 percent year-on-year in December and is forecast to stay around that pace this month.

The S&P 500 Wednesday closed down a half percent at 2,681, after rising as much as 1.2 percent. Both indexes were on track for their largest single-day losses since February 2016. US government bonds, meanwhile, are considered virtually free of risk of default.

Since the bond scare began about a week ago and the 10-year Treasury yield hit a four-year high of 2.88%, the Dow Jones industrial average has tumbled as much as 10.7% from its January 26 high and has behaved erratically.

"I would think that this continues to happen for the next few trading sessions for everything to kind of get flushed out". It's been pretty ugly.

"There's going to be an interplay, a bit of push and pull between the rates market and equity market", said Mark Cabana, head of USA short rate strategy at Bank of America Merrill Lynch.

Earlier on Thursday, the 10-year U.S. Treasury note yield rose as high as 2.884 percent, just below Monday's four-year peak of 2.885 percent, after the Bank of England said interest rates probably needed to rise sooner than previously expected. "Now they are saying we will take out the steroids, because it could have side-effects", said Nilesh Shah, MD at Kotak AMC. "These rising twin deficits, increasing interest rates - it's reminiscent of 1987 before the market crashed".

"It is hard to see the 10 year US Treasury breaking much above 3 to 3 ¼% without a sustained increase in inflation, which would raise expectations of more aggressive central bank tightening".

"You could get into a little bit of circular logic here, as you hand leadership back and forth".

"People have become quite trained on seeing only positive returns from their bond funds", said Mike Dowdall, investment strategist at BMO Global Asset Management.

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Fear has now replaced greed in the stock market.

"Higher rates are going to slow the economy, we just don't know when and we don't know which rates to watch, and I think that's the debate that's now playing out in the market", he said.

But with the Federal Reserve seen likely to raise short term interest rates another three or four times in 2018, bond yields have been rising, and last Friday's healthy USA labor market report sparked fears of rising inflation, leading to Monday's sharp bout of profit taking.

"It's just the latest log on the fire", said Schumacher. The Treasury is also having to borrow more money, partly because of the tax cuts, and issuing more debt tends to raise yields. Core inflation, which is growing at less than 1%, would need to rise substantially for bond prices to see a more meaningful increase.

Equities for years have looked relatively attractive compared to the low yields offered by bonds.

"We have seen the US Fed warning the markets that it would be raising interest rates".

"A strong currency puts a lid on inflation and helps keep interest rates low", writes Rebecca Patterson, chief investment officer of Bessemer Trust, in a opinion piece.

LPL Research released a report titled "Volatility is Back", which pointed to fear of rising interest rates as the source of the recent swings but cautioned that the economy is fundamentally strong.

Critics of the Fed's policies say the central bank not only has created repeated asset bubbles, but also has encouraged borrowers, especially the USA government, to sap their spending power by going deeper and deeper into debt.

"Over the last half a dozen of years we have been saying equity valuations can be higher because we are living in a low interest rate and low inflation environment but that's reversing a little bit and that's what we are staring at now", said Art Hogan, chief market strategist at B. Riley FBR in NY.

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