Markets right to fret about rising interest rates

The fall in equity prices over the past couple of weeks is hard to square with the recent economic data, which suggest that GDP growth was 3.0% annualised in the third quarter. The sell-off appears instead to be a delayed response to the renewed surge in Treasury yields over the past couple of months, which has fuelled concerns about the impact of tighter Fed policy on the economy. We think markets are right to be alarmed. Real two-year Treasury yields have already risen by over 200bp over the past few years, matching the increases ahead of each of the past three recessions. There are already signs that rising borrowing costs are weighing on rate-sensitive sectors of the economy, in particular the housing market. With the boost from fiscal stimulus set to fade, this is a key reason why we expect economic growth to slow sharply next year, prompting to Fed to stop raising interest rates sooner than most anticipate.