By Daniel Kruger 

The yield on the benchmark 10-year U.S. Treasury note has climbed back to near a seven-year high, a sign of increased optimism that trade disputes and problems in emerging markets won't derail the global economy.

Encouraged by data showing robust U.S. growth, rising wages, gains in corporate profits and persistently low unemployment, investors have pushed stocks to records and ramped up their selling of government debt. At the same time, forces that had weighed on bond yields, such as worries about tariff fights and turmoil in countries including Argentina and Turkey, have eased.

That leaves investors grappling with a tension between the economic strength that seems primed to push stocks and other riskier assets higher and concerns that those gains could be derailed by anything from the fight over global trade to tightening monetary policy. The Federal Reserve is expected to raise interest rates this week, for the third time this year, with investors watching officials' forecast for 2021 seeking clues as to how long policy makers think the expansion can continue.

Rising Treasury yields are important because they serve as a reference rate for lending throughout the economy, influencing borrowing costs for homes and cars, or the price of debt for credit-card holders and businesses. Many analysts say a sustained climb above 3% in the 10-year yield would mark the latest sign of the economy's gradual postcrisis strengthening after years of ultralow rates.

"The wall of fear that we were talking about just two weeks ago -- be it Italy or trade wars or emerging markets -- it seems like it's completely collapsed," said Priya Misra, head of global rates strategy at TD Securities. However, it is "not clear to me that any of these risks have fundamentally been solved," she added.

The yield on the 10-year Treasury note, which rises as bond prices fall, climbed as high as 3.10% in intraday trading last week, up from 2.85% at the start of September and near its 2018 closing high of 3.11% reached May 17. It is approaching its highest level since July 2011.

One sign the climb in yields is based on investors' increased appetite for risk can be seen in the stability of market-based inflation expectations. Because inflation poses a threat to government bonds by eroding the purchasing power of their fixed payments, rising inflation expectations often accompany climbing yields. Yet one measure of those expectations, known as the 10-year break-even rate, indicates investors see the annual rise in the consumer-price index for the next 10 years has been relatively steady lately at around 2.1 percentage points.

While yields are rising, they remain low by historical standards, bolstering many analysts' view that the economy can withstand modest near-term increases in borrowing costs.

At the same time, investor confidence has climbed while volatility has eased. Stock gains have bolstered the portfolios of higher-income people, while the tightening labor market and rising wages have made people in lower-income groups more optimistic, said Ellen Zentner, chief economist at Morgan Stanley. The Dow Jones Industrial Average closed at a fresh record on Friday.

Investors are also less worried that rising bond yields could provoke declines in stock prices than they were earlier in the year. In February, stocks tumbled after the 10-year Treasury yield reached 2.85%, prompting concerns that rising borrowing costs could derail the expansion. Strong economic growth has moderated the risk that higher yields will undermine stocks, several analysts said.

Many analysts expect yields to top out soon, moderating concerns that a substantial climb could hinder growth. A significant surge in rates could have a chilling effect on consumer and business spending, particularly in parts of the economy where consumers need access to credit, such as housing and cars.

Some already see the effect on consumers. The rising cost of credit for big-ticket items such as homes and autos is "having an effect on financial decisions" for middle- and lower-income consumers, said Dan Heckman, senior fixed-income strategist at U.S. Bank Wealth Management. "It's an affordability issue" and threatens to weigh down economic activity.

The yield on the two-year note, which typically moves in line with expectations for monetary policy, has climbed faster than the 10-year yield in 2018. That reflects a narrowing dispersion between shorter- and longer-term rates, known as a flattening yield curve. Many view a flattening yield curve as a cautionary signal, as recessions have followed each time short-term rates have exceeded long-term yields since 1975.

Recent weakness in the dollar, however, is another factor suggesting yields could keep climbing in the short term. The WSJ Dollar Index has declined 1.4% since reaching a 15-month high on Aug. 13. Investors had sought assets denominated in the world's reserve currency amid concerns that tariff disputes could slow international trade and that emerging-market economies facing severely elevated levels of inflation could cause problems that leading to losses in developed markets.

The dollar's decline "reveals a lot of information" about increased stability in emerging markets, improving risk tolerance and the easing tensions over trade, said Stephen Bartolini, a bond fund manager at T. Rowe Price. "There's still a reasonable amount of doubt that tariffs are a long-term" problem for the economy, he said.

--Sam Goldfarb contributed to this article.

Write to Daniel Kruger at Daniel.Kruger@wsj.com

 

(END) Dow Jones Newswires

September 23, 2018 10:14 ET (14:14 GMT)

Copyright (c) 2018 Dow Jones & Company, Inc.