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(Jupiterimages/(C) 2008 Jupiterimages)
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Market Blog

Pain threshold nears with bond yield Add to ...

Keep an eye on the 10-year Treasury bond yield: It has been climbing fairly steadily since Federal Reserve chairman Ben Bernanke floated the idea (now a reality) of a second round of quantitative easing last August. Back then, the yield sat at just 2.5 per cent, but has since moved to 3.67 per cent.

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That's a cause for some concern, since the bond yield reflects borrowing costs, inflation expectations and a potential investment alternative to stocks. Therefore, equity investors get nervous when the yield rises to uncomfortable territory.

But where is this territory? David Rosenberg, chief economist and strategist at Gluskin Sheff - and everyone's favourite bearish commentator - looked at 10 previous "hiccups" in the bond yield over the past three years. The average peak in the bond yield has been 4.05 per cent, with a range between 3.85 per cent and 4.3 per cent - which implies that the stock market is nearing its pain threshold.

"Even if we go back to the peak of these hiccups, it would still mean we are two-thirds of the way through this; if we end up peaking out at the lower end, then we are 86 per cent of the way there," he said in a note.

In previous episodes of rising bond yields, the stock market has certainly suffered. However, Mr. Rosenberg is taking the perspective of bond investors here. They are none too pleased to see yields rising, since yields rise when bond prices fall.

However, the good news for bond investors is that rising yields tend to be self-correcting. As Mr. Rosenberg explains: "Even last year, that move to 4 per cent in April brought the stock market down to its knees and this ended up helping turn the Treasury market's fortunes around. In other words, these bond selloffs end up being self-correcting once the damage starts to seep into the stock market."

"And 4 per cent seems to be the yield that the equity market tends to respond to and not in a very friendly way. The good news for the stock market investor - we are still 35 basis points away. But at the rate things are going, we may get there by the middle of February."

 

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