With Apple (NASDAQ:AAPL), oil prices and the 2012 election dominating the headlines, a new potential worry for investors has very quietly emerged in recent days: surging bond yields.
Almost out of nowhere, the yield on the benchmark 10-year Treasury bond has quickly shot to five-month highs as investors price in further evidence the U.S. economy is truly recovering and inflationary concerns begin to emerge via triple-digit oil prices.
On the one hand, the bond-market turnaround is a positive development because it shows investor appetite for risk has grown to the point that higher yields, which move in the opposite direction of prices, are needed to attract cash.
“The backup in the 10-year U.S. Treasury bond yield since late February certainly reflects mounting confidence in the strength and sustainability of economic growth,” Ed Yardeni, president and chief investment strategist at Yardeni Research, wrote in a note.
On the other hand, a sudden leap in Treasury yields could slow the economy by raising the price of credit linked to the 10-year note such as mortgages.
“Everything is pretty fragile right now. Everyone is pretty concerned that if you have a rapid rise in yields, you run the risk of at best slowing things down,” said Dan Greenhaus, chief global strategist at BTIG.
Under the Radar
Rising for the fifth session in a row, the yield on the 10-year Treasury note hit 2.375% on Monday -- its highest level since late October. While it’s nowhere near the levels of before the crisis, the yield has soared 0.346 percentage points over the past five trading days alone.
So far, the markets appear to be mostly unfazed. The S&P 500 reached its highest close since 2008 on Monday, putting it on track for its strongest first quarter since 1998.
While this story has so far remained under the radar, expect the bond markets to begin to become an obstacle for stocks if the rapid rise in yields continues.
“This is really important and it’s not getting anywhere near the attention it should get,” said Peter Kenny, managing director at Knight Capital Group.
Greenhaus seconded that, saying, “People really have to catch up to the fact this is happening. We’ve become so used to low bond yields for some time now it takes a couple of days to sink in.”
Markets Price in Fed, Improving Economy
The same upbeat economic reports that are juicing stock prices have also changed the sentiment in the bond markets, causing investors to increasingly believe the Federal Reserve will step off the easy-money gas pedal. After the central bank’s policy statement was released last week, many began to bet a third round of bond-buying was not in the cards and interest rates could be raised in the beginning of 2014.
At least some strategists believe that new thinking on monetary policy is overdone.
“We believe the market is being too aggressive,” analysts at Barclays wrote in a note released on Friday. “We believe the Fed will display some inertia in beginning the hiking cycle even if the unemployment rate were to decline faster” than previously expected, the firm wrote.
Greenhaus warned against assuming the Fed is as sold on the economic data as the markets are.
Meanwhile, rising prices, especially in the energy markets, have fueled some concern about inflation that is now being priced into the bond markets. Crude oil prices climbed by another $1.03 on Monday to hit $108.09 a barrel, leaving them up almost 10% so far this year. According to AAA, the national average price of gasoline stood at $3.842 a gallon, up 8.5% from a month ago.
“Clearly inflation expectations have risen. There are no two ways about that,” said Greenhaus.
Will Higher Rates Help or Hurt Housing?
One of the most important sectors that could feel the impact of higher yields is the housing market, which is still very fragile despite signs it may have finally hit a bottom in at least some areas of the U.S.
According to Bankrate.com, the average rate on the benchmark 30-year fixed mortgage crept up last week to 4.15% from 4.11%, while the jumbo 30-year fixed mortgage rate leaped to a three-month high of 4.73%.
Higher mortgage rates could provide a disincentive to buy homes, creating a new headwind for the slowly healing housing market.
Conversely, the prospect of paying higher rates down the line could actually persuade some prospective buyers to make a purchase now rather than wait.
“It’s going to become a balancing act,” said Kenny. “In some respects, rising yields, as counterintuitive as this sounds, are actually going to drive demand for housing because people will be afraid to miss out. This could help the stabilizing housing market find a bit of an accelerant.”