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Why you should not freak out about the 10-year U.S. Treasury yield hitting 1.7%

Dow Jones2021-03-22

The weeks after Spring Break could be very telling in terms of economic recovery

Americans like to say: Go big, or go home.

But after a year of staying home, investors have begun to worry about potentially losing money, or getting caught wrong footed in their investments, if the U.S. government overshoots in its support for the economy and causes an inflation hangover.

One reason for the cringe has been the sharp, seven week upswing in benchmark government bond yields, with the 10-year Treasury rate at 1.729% Friday, from a low a year ago of 0.51%.

"There are certain rules of thumb," said Joe Ramos, head of U.S. fixed income at Lazard Asset Management, about financial markets. "One is rising rates are bad."

The thinking goes that if companies pay more to borrow they will pass on the rising costs to consumers by jacking up prices on goods and services, causing households to spend more, but getting less bang for their buck. Any pullback by spenders could hurt the recovering economy, even before it fully reopens from the lockdowns imposed to combat the coronavirus pandemic.

But Ramos also thinks some old rules for financial markets have met their past due date and should be retired, particularly after yields in the $21 trillion U.S. government Treasury market tumbled to last year's record lows .

U.S. Treasurys long have served as a reliable asset class for institutional investors seeking protection against deflation, Ramos said, but he also called what drove Treasury yields so low last year a "sign of sickness," when it "looked like the world was going to fall apart on us."

Rising yields in today's environment come as more Americans get vaccinated and Google searches for Disney vacations spike, signs of an economy returning to health, according to Ramos. "One thing I tell people is that they are going to be able to afford more, even though it's going to cost more," he said.

Powell Patience

This idea hinges on the ability of the U.S. to reclaim some 9.5 million jobs lost during the pandemic. Federal Reserve Chairman Jerome Powell said Friday in an op-ed that he plans to support the U.S. economy "for as long as it takes," but also said the outlook has been brightening.

Powell called attention to the necessity of the central bank's extraordinary steps to shore up financial markets amid the turmoil unleashed a year ago by climbing COVID-19 cases. A year later, the U.S. has jumped ahead of Europe and other parts of the world in terms of vaccinations, leaving Wall Street looking for clues about what comes next.

"The big picture is that it really matters why rates are rising," said Daniel Ahn, chief U.S. economist at BNP Paribas. "It's not just the levels, but the facts behind it, and the Fed has been sounding pretty sanguine about these moves higher, because of the improving outlook on the economy."

Ahn also pointed out that credit spreads $(LQD)$, or the premium investors are paid above Treasuries to compensate for default risks on corporate debt, haven't gapped out significantly, despite the rapid rise in long-term U.S. debt yields over roughly two-months.

The U.S. dollar hasn't shot up sharply either, nor has the Dow Jones Industrial Average or S&P 500 sunk into correction territory, even though the technology-heavy Nasdaq Composite has been under pressure. All three benchmarks booked a weekly loss Friday.

Perhaps another 70 basis point rise in the benchmark 10-year U.S. Treasury yield over the next two months might be enough to trigger broader market volatility. "But we haven't seen that yet," Ahn said.

Related:There will be no peace' until 10-year Treasury yield hits 2%, strategist says

What? Expensive Credit

It has been 40 years since the prime U.S. lending rate exceeded 20%, back when former Fed Chair Paul Volcker waged a lasting battle against runaway inflation.

Since then, generations of U.S. homeowners have been able to snap up 30-year fixed rate mortgage rates at 5% and they are now nearer to 3%.

"Obviously, what inflation means differs for savers and Main Street from Wall Street," said Nela Richardson, ADP's chief economist, adding that people still bought homes and took out home loans when mortgage rates were at 18% in the 1980s.

"Bond investors are more confident in an economy that requires higher yields to hold relatively safe assets," Richardson said, but he added that markets tend to get jittery if higher yields end up meaning "the end of cheap money and virtually free credit."

Trillions of dollars worth of pandemic fiscal stimulus from Congress coursing through the economy, just as more U.S. vaccinations potentially lead to a broader reopening of businesses this summer, could put inflation expectations to the test.

"Because we haven't seen inflation since Volcker, I think market participants are concerned this could unleash it," said Brian Kloss, global credit portfolio manager at Brandywine Global.

Kloss said "basic industries, commodities and companies that have pricing power," should do well for shareholders in an inflationary environment, but he also cautioned that in the coming few weeks, following spring break gatherings, that the U.S. will have more clues as to the status of the COVID-19 threat.

If the U.S. can avoid a spike in new coronavirus cases, unlike Europe where further lockdowns remain a threat, it "could be one of the first signs of a robust summer, heading into fall," he said.

Meanwhile, the bond market appears to already be signaling it has embraced the Fed's commitment to keeping monetary policy accommodative for some time to come, said Robert Tipp, PGIM Fixed Income's chief investment strategist.

He pointed to Treasury break-even rates that recently topped 2% as a signal that the bond market expects inflation to creep up from emergency levels, based on break-evens, an indicator of future price pressures .

But even if 10-year rates climb back to 3% and inflation rises along with the Fed's new 6.9% GDP growth forecast for this year, Tripp expects both to fall back to the lower levels familiar over the past four-decades.

After the 2008 global financial crisis, people were forecasting "inflation Armageddon" and that the "Fed would never be able to get out of that policy" of quantitative easing, he said.

"But of course they did," Tipp said.

Next week will bring a deluge of U.S. economic data. Monday and Tuesday will see the release of existing and new homes sales for February. Wednesday brings February's durable goods orders, as well as preliminary March manufacturing and services sector index updates.

It's weekly jobless benefit claims data on Thursday and the final estimate of fourth quarter GDP, while Friday will show the latest data on personal incomes, consumer spending, core inflation for February and the latest consumer sentiment index reading.

Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.

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Comment45

  • Suenwins
    ·2021-03-22
    The speed of 10-year yield rising is concerning indeed. However, we should not be too conservative sometimes and should always remember that the rising yield indicates stronger economy activity.While we look at the 1-year Treasury yield which reflects the liquidity of the market cashflow, it does not seem to be worrying. Before the state would declare the raise in the interest rates, we shall see less fiscal stimulus as a sign of balance sheet reduction. The rise of interest rates would be super harmful and impact thefast growing companies which currently still under a loss from operation.Also, recent sector rotation is good for the market to prevent the burst of some tech bubble.It is also a good chance for those high valuation company to come to adjust their high P/E and e
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    • Suenwins
      Is concerning indeed*
      Why tiger broker always correct my comment and become not accurate alreadY ?
      2021-03-22
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  • lihodinho
    ·2021-03-22
    It is normal yield going up. Before pandemic also around 3++. Now goin back normal.  Whats so worry? 
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    • Suenwins
      The speed of it going up
      2021-03-22
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    • ZEROHERO
      Everything moves in cycle
      2021-03-22
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  • CubTrader
    ·2021-03-22
    So how? Buy more to keep before economy really recover?
    Reply
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  • TohKokMeng79
    ·2021-03-22
    10years..
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  • Supertooth
    ·2021-03-22
    Buy more
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  • Sirdancelot
    ·2021-03-22
    1
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  • Ohyzzz
    ·2021-03-22
    Hmmm
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  • trollololol
    ·2021-03-22
    Like and reply please
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    • 小獭獭
      Please like and comment ❣️
      2021-03-22
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    • sgric
      done
      2021-03-22
      Reply
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  • max941
    ·2021-03-22
    Hmmm
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  • ST2021
    ·2021-03-22
    Ok [呆住] 
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  • Vin309
    ·2021-03-22
    Comment and like
    Reply
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    • Fumiyo
      ok
      2021-03-22
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  • jimmylaw
    ·2021-03-22
    Wowwww
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  • Goldlim
    ·2021-03-22
    Please help to comment and like. Thank you
    Reply
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    • deneee
      ok
      2021-03-22
      Reply
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    • 小獭獭
      Please like and comment ❣️
      2021-03-22
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  • AlvinTham
    ·2021-03-22
    Comment & like pls, thanks!
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    • Blurryw
      Nice
      2021-03-22
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    • sgric
      done
      2021-03-22
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    • auahau
      done! comment back too :)
      2021-03-22
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  • Huatah888
    ·2021-03-22
    Yes
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  • sinkiat
    ·2021-03-22
    like and comment please!
    Reply
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    • Timtan85
      Like and comment pls
      2021-03-22
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    • Vin309
      Ok
      2021-03-22
      Reply
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    • AlvinTham
      Comment & like pls, thanks!
      2021-03-22
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  • Nebhol
    ·2021-03-22
    Buy the dip if possible
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    • valueTrader
      buy and hold. market will recover
      2021-03-22
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  • YangLex
    ·2021-03-22
    .
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  • Jchptan
    ·2021-03-22
    Comment pls
    Reply
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    • Jchptan
      Hi
      2021-03-22
      Reply
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    • sinkiat
      done. comment back please!
      2021-03-22
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  • Jchptan
    ·2021-03-22
    Comment pls
    Reply
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    • Jchptan
      Hi
      2021-03-22
      Reply
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