Bond Yields Climb as Investors Embrace Risk, Cautiously
23 September 2018 - 04:29PM
Dow Jones News
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)
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