10-year Treasury yield testing 2% for first time since May

Another bullish indicator for stocks, though maybe not for interest rates

Jan 28, 2013 @ 2:59 pm

By Jeff Benjamin

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The new risk-on trade that has driven the S&P 500 above the 1,500 mark for the first time in more than five years also is forcing Treasury bond yields to move against the best intentions of central bankers.

The yield on the 10-year Treasury bond is hovering around 2%, which is a level it hasn't seen since May. It represents a huge recovery from the 1.4% bottom it hit in July.

However, while the Treasury yield bump does reflect a shifting of money toward riskier assets, it doesn't necessarily represent a major shift in the direction of interest rates, according to Robert Tipp, chief investment strategist for fixed income at Prudential Financial Inc.

“Everybody is clearly primed for that shift from bonds to stocks, but I think right now, we're still mostly seeing a shift from cash to stocks,” he said. “It's not surprising to see Treasury yields rise as people start to acknowledge the better news that's out there.”

Among the points driving the more bullish spirit are improved economic data from both Europe and the United States, as well as positive developments out of Washington related to taxing and spending policies, Mr. Tipp said.

However, the market previously has seen similar Treasury bond mini-rallies that ultimately fizzled out, he said.

“This is how it has been every year for the past few years,” Mr. Tipp said. “Things start off looking really good, but the last two years we've had a mid-year drop-off in the data.”

The Treasury market is expected to be particularly sensitive to a raft of economic data coming out this week, according to Dan Heckman, a senior fixed-income strategist at U.S. Bank Wealth Management.

The data stream kicked off Monday with durable-goods numbers coming in at a level about three times higher than the market was expecting.

On Tuesday, the market will absorb key housing and consumer confidence data, followed by employment data Wednesday, Thursday and Friday.

“I've never seen a week so heavy in economic data, and I think the Treasury market will be sensitive to it,” said Mr. Heckman, who also will be watching the bond market's appetite for a new issuance of Treasury bonds, scheduled for this week.

“This week will be a good poll for how 2012 ended and for how 2013 will take off,” he said.

The consensus forecast, according to a Bloomberg survey, is for the 10-year Treasury to finish the year yielding 2.2%, which is about where the yield was in March.

That makes perfect sense to Russ Koesterich, global chief investment strategist at BlackRock Inc.

In a report released Monday morning, he described the rising Treasury bond yields as the start of the “long-awaited back-up in rates.”

“We expect yields to rise in a slow erratic process over 2013, climbing to perhaps 2.25%,” Mr. Koesterich wrote.

Of course, he also acknowledged the force preventing yields from taking off, which boils down to the continuing Treasury buying binge by central banks.

Any subtle move away from the safety of Treasury bonds by individuals and institutional investors is offset by the pace of central bank bond buying, including the purchase of $85 billion per month in Treasury bonds and mortgage-backed securities by the Federal Reserve.

The Fed's balance sheet is now at an all-time high of $3 trillion.

Another factor likely to keep Treasury yields in check indirectly is the new and still largely unrealized reality of higher taxes.

“There has been a lot of good economic data recently, but it's all backward-looking data,” Mr. Tipp said. “Keep in mind that we just had a tax increase in the U.S., and we will find out soon what kind of an impact that will have on retail sales.”

In essence, any indicators of slower economic growth could put the brakes on the risk-on move by investors, thus moving money back into the safety of Treasury bonds and bringing yields back down in short order.

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