The recent rise in U.S. bond yields might represent a growing fatigue among investors in having to digest another batch of U.S. Treasuries – one report puts next week's sale at an estimated $74-billion (U.S.) – but it can also be viewed as bullish for stocks.
The U.S. Treasury Department today is scheduled to release the exact amounts of three-year, 10-year and 30-year notes it plans to auction next week.
A rise in yield often precedes the Treasury announcement as investors anticipate the increase in bond supply will cause prices to fall and yields to rise.
The yield on 10-year U.S. Treasuries rose seven basis points to 3.83 per cent Wednesday. (A basis point is 1/100th of a percentage point.)
Growth prospects robust
That brings the difference in the 10-year and two-year yields – the yield curve – to 283 points, which is just shy of the record 288 points set Dec. 22, according to Bloomberg.
“That is indicating that the economy has the potential to accelerate much more than anyone is anticipating,” said Kent Engelke, chief economic strategist and managing director of Capitol Securities Management Inc.
The rise in long-term interest rates also reflects growing inflation worries as the economy recovers.
A rebound in housing and autos could result in the economy growing at a 5-per-cent rate in 2010 and potentially drive the S&P 500 up another 10 to 12 per cent, Mr. Engelke said.
How will the market react?
Market timers might even be able to do better. There could be a period in which stock markets decline as the U.S. Federal Reserve Board changes its monetary policy and begins to raise interest rates, Mr. Engelke said. He describes this as a “good news is seen as bad news phase.” Worries over the change in Fed policy could cause the S&P 500 to fall 5 per cent to 7 per cent before it renews its climb, he said.
The current Fed funds rate of about zero could be raised to 1 per cent to 3 per cent and still accommodate growth, Mr. Engelke said. “The longer the Fed delays in increasing short-term interest rates, the greater is the probability of a 5-per-cent yield on [10-year] U.S. Treasuries.”
Sharply higher interest rates – as a 10-year Treasury yield above 5 per cent implies – would destabilize the recovery in U.S. real estate and the banking system, said David Bianco, chief U.S. equity strategist for Merrill Lynch & Co. Inc. in a report to clients this week.
