The yield on the benchmark 10-year Treasury bill vaulted above the 3% threshold on Friday, hitting the highest level in 2-1/2 years as investors move away from fixed income amid the improving economy and shifting Fed policy.
Market participants are closely watching the action in the bond market as rising yields signal increased confidence in the economy, but also create a headwind in the form of more expensive credit for key items like mortgages.
Higher rates “are not on their own something to fear. Indeed, rates have moved markedly higher in 2013 but so have stock prices,” Dan Greenhaus, chief strategist at BTIG, wrote in a note to clients Friday morning.
On Friday, the 10-year yield, which moves in the opposite direction of its price, rose as high as 3.011% -- the highest level since July 2011.
That puts the 10-year yield on track for its fourth consecutive increase and sixth in the past seven trading days. It’s been on an upward trend for much of the year, with the yield having surged around 1.3 percentage points over the past 12 months, according to Dow Jones data.
All of this comes after the Federal Reserve somewhat surprised Wall Street last week by saying it will dial back on its $85 billion in monthly bond purchases aimed at stimulating the economy. Rates had been moving higher in anticipation of the Fed eventually tapering its quantitative easing program.
The higher bond yields have a trickle-down effect on the cost of borrowing for businesses and consumers. For example, the 30-year, fixed-rate mortgage rate averaged 4.48% for the week ending December 26, up dramatically from 3.35% the year before, according to Freddie Mac.
Higher borrowing costs make buying real estate more expensive. Recent stats show existing home sales dropped 4.3% in November to a seasonally adjusted annual rate of 4.9 million units.
Greenhaus notes that the action in the bond market reflects not just Fed policy but stronger U.S. growth. Recent government statistics show U.S. gross domestic product jumped 4.1% in the third quarter, the fastest pace of growth since the fourth quarter of 2011.
“Simply put, if the U.S. economy is going to perform better in 2014 than 2013 -- and we expect it will -- then yields will have to move higher. Not because of the Fed tapering (although that’s part of it) but because that’s just what happens,” Greenhaus wrote.
So far, Wall Street does not appear to be overly spooked by the bond-market action. Stocks were set to open slightly higher on Friday, a day after the Dow Industrials soared 122 points and notched their 50th record close of the year -- the most in a single year since 1995.
Others take a more cautious stance on the fact that rates are rising as the economy is improving.
“Stocks are certainly looking at the rise in rates as the glass being half full in that it’s happening coincident with a hoped for sustainably improving economy,” Peter Boockvar, chief market analyst at The Lindsey Group, wrote in a recent note. “This scenario always begs the question of what upward level of rates tips the economy and the markets.”