Why Stocks Zigged While Bonds Zagged

The Dow Jones Industrial Average plunged by more than 200 points on the last day of May. Fortunately, yields on Treasury bonds held up much better, and that could bode well for the direction of bank rates.

The environment for stocks and bonds

For the most part, recent weeks have seen a steady stream of encouraging economic news. In response, stock prices and bond yields have been rising.

Keep in mind that bond yields rise when bond prices fall. In effect, the stock market and the bond market often have different rooting interests -- the stock market benefits from the improved corporate earnings that come with economic growth, while bonds tend to thrive when a weak economy drives interest rates down.

Despite these different interests, stock prices rising and bond prices falling meant the two markets were in sync about the economic environment -- until they fell out of step at the end of May.

What happened at the end of May

While stock prices were falling on the last day of May, bond yields actually rose. The reason is that falling stock prices were not a function of diminished confidence in the economy. Just the opposite -- lately the fear has been that the economy has been improving so fast that the Federal Reserve might end its monetary easing programs sooner than expected.

Stocks benefit from the low interest rates those programs have brought. On the other hand, softening Fed intervention would be welcome news to customers of savings accounts and other deposits who have been waiting for years for interest rates to rise.

Looking for higher bank rates

Interest rate moves are seen first in actively traded bond markets, but they can take longer to trickle down to bank rates. However, the further bond yields move, the more likely it is that bank rates may follow. Since there's no telling when this might happen, here are three things you can do to be prepared:
  1. Keep an eye on current savings account rates. Not all banks react the same way to a rising interest rate environment, so shop actively to spot the banks that are on the leading edge of the movement toward higher interest rates.
  2. Check out online savings accounts. Online accounts frequently offer the most competitive rates, so expect them to be among the leaders in reacting to a rising rate environment.
  3. Be prepared to re-evaluate CDs. This may take a little longer to come about, but as interest rates rise, it may be time to start considering longer-term CDs again. Watch to see if the spread between longer and shorter CD rates starts to widen.

Because the stock market welcomes improved corporate earnings but does not want to lose the support of Fed monetary easing, its movements have evidenced mixed feelings about the recent strengthening of the economy. Interest rate markets have no such ambivalence -- if economic progress continues, expect bond yields to keep rising, with bank rates eventually following.