Long-term U.S. bond yields have crept within reach of 3% for the first time in years, a sign that robust global economic data are overcoming longstanding investor fears about the staying power of the postcrisis recovery.
The great shift from stocks to bonds
The development has significant implications for financial markets. The half-percentage-point rise this year in the 10-year U.S. Treasury note yield, a barometer that influences borrowing costs for governments, consumers and corporations, contributed significantly to the 10% tumble in the Dow Jones Industrial Average (.DJI) earlier this month, many analysts say, by upending favorable valuations based on lower rates.
But stocks have bounced back over the past week, reflecting continued optimism about the outlook for growth and corporate earnings. Rising share prices—alongside increasing bond yields—suggest markets are getting over their obsession with "secular stagnation," many investors say, referring to the hypothesis that growth and interest rates will remain depressed for years as economies around the globe grapple with stalled wage growth and soft employment.
Those concerns "don't apply any longer," said Jim Vogel, head of interest-rate strategy at FTN Financial.
Concerns now center on long-dormant inflation and central banks' efforts to step back from extraordinary stimulus measures. The yield on the 10-year U.S. Treasury note was 2.88% Friday after hitting 2.91% on Wednesday, its highest level in four years. That is up from 2.41% at the end of 2017.
Investors will look to a speech this week by Federal Reserve Bank of Atlanta President Raphael Bostic, whose outlook in the wake of recent above-forecast U.S. inflation data could provide "an important detail" reflecting the evolution of thinking at the central bank on interest-rate policy, said Aaron Kohli, an interest-rate strategist at BMO Capital Markets.
The tension surrounding the rise in yields comes as the Fed continues to back away from the stimulative policies it employed during the financial crisis. As it raises interest rates and reduces the size of its bond portfolio, it is pulling money out of the economy at the same time financial markets are becoming increasingly volatile. Some investors and analysts said that those crosscurrents could help push yields past that 3% for the first time since 2013.
Another factor that some investors say could push yields past the milestone is the government itself. The rise in yields has coincided with the passage of $1.5 trillion in tax cuts, and the larger budget deficits threaten to drive up yields as the government boosts the amount of bonds it sells to finance the cuts.
This week, the Treasury is scheduled to sell $107 billion of notes, a $4 billion increase from the same series of auctions the month before.
The tax cuts have also been a key part of the stock-market rally and have lifted inflation expectations, with analysts saying companies could opt to raise worker wages or invest in capital projects with some of the savings.
Even now, yields remain low by precrisis standards. What's more, long-term market pricing remains less than euphoric, reflecting fears that climbing yields over time will slow the economy by making borrowing more expensive for consumers and businesses.
The implied inflation forecast from inflation-indexed Treasurys this year has peaked at 2.14% for the next 10 years. The implied forecast from inflation bonds maturing in 2047 is just 2.13%. That suggests that growth continues to face structural challenges such as an aging population, rising debt burdens and sluggish productivity growth.
The rise in wages "is getting close to its cycle high," said Peter Yi, a bond manager at Northern Trust.
While the U.S. economy remains poised to grow, "our fiscal policy has undercut confidence to some extent," said Nathan Sheets, chief economist and head of global macroeconomic research at PGIM. That has "dented" the status of the U.S. as a haven, and helped push bond yields higher while weakening the dollar, he said.
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