Dow drops 450 points as 10-year Treasury yield hits 5%

U.S. stocks experienced a significant decline on Tuesday as the 10-year Treasury yield crossed the 5% threshold for the first time since 2007. Investors were anticipating a Federal Reserve interest-rate decision expected for the following Wednesday. The Dow Jones Industrial Average fell by approximately 449 points, or 0.86%, while the S&P 500 and Nasdaq Composite both experienced a modest decline of around 0.34% and 0.48%, respectively. The 10-year Treasury yield reached a peak of 5.041% before stabilizing around 5.011%.

Oil prices continued to rise following Saudi Arabia's closure of a crucial pipeline bypassing the Strait of Hormuz. Brent crude futures for November delivery surged by about 1.6%, trading above $107 a barrel, while West Texas Intermediate futures reached over $103.

Market observers believe there is a high probability, between 90% and 93%, that the Federal Reserve will raise its benchmark rate by a quarter percentage point on Wednesday, potentially raising the upper bound of the target range to 4%. Fed Chair Kevin Warsh is expected to signal that this rate move is not a commitment to further hikes and emphasize the discretion the Fed has for subsequent meetings, as reported by CNBC.

Christopher Hodge, chief economist for the U.S. at Natixis CIB Americas, stated that the Fed Chair is likely to highlight the discrete nature of the decision, allowing the Committee maximum flexibility to respond to unforeseen circumstances. Hodge added that this signal may provide some relief to the equity market, which had been suffering losses, with the S&P 500 and Nasdaq experiencing a cushion due to gains in several artificial intelligence-related stocks.

However, strategists at Barclays cautioned that higher yields posed growing risks for equity investors, with the 5% mark on the 10-year yield serving as a historical threshold that has often preceded a more persistent headwind for equity markets. Given lingering inflation concerns and rising yields, the protective effect provided by earnings growth might become increasingly challenging to sustain, according to the strategists.

The confluence of higher yields and crude prices suggests growing apprehension that the U.S.-Iran conflict could fuel inflation and prolong the Fed's tightening stance.