Curious, have you come across anything recent about bond yields rising? A Google search on “end of bond bull market” pulled up 13.3 million articles about that in 0.45 seconds. A search on “bond bear market” came up with 11.4 million. In context, anything related to bond bull or market came up with 1 to 4 million references. I guess that cat is out of the bag, huh?
An article, more a blurb, in the Wall Street Journal’s Heard on the Street, put it succinctly last Tuesday with the headline “In Treasury Market, There Are Reasons to Expect Trouble.” It starts off saying 3.5 percent 10s is doable by the end of the year. Behind that potential are (1) the price action so far this year, (2) the behavior in TIPS on the back of gains in oil, various wage hikes and bonuses in “celebration” of the tax cuts, (3) the acknowledged “dubious” reports about China buying less and (4) the BoJ buying fewer JGBs. There’s more. It talks about (5) “undigested” factors like more bond issuance to deal with the expanding deficit, (6) the White House’s stance on trade and how that might raise import prices while reducing demand for U.S. assets and finally (7), it tackles the term premium, negative, simply rising to zero (from -45 basis points). Add all that up and they say 3.5 percent is within reach.
And that’s all good and fine and all, and I, too, am somewhat in the bearish camp though not to 3.5 percent. That level implies a steeper curve, sharply so, assuming the Fund’s rate closes near 2 percent and change.
I’m not knocking what they wrote at all. However, I didn’t read anything new. I didn’t have a chance to read all of the 13 million Google finds on the end of the bond bull market, but enough to give me the gist of that matter. To items 1 to 7, I can add (8) the softer tone to the dollar, amid (9) better global growth, which is provoking (10) tighter monetary policies and less QE in most of the G7. What I’m saying is we know all this and have for a while and the price action that starts the new year, which is seasonally habitually bearish even in bull markets, is not necessarily a prologue especially when risk assets—read stocks—are also subject to all of the above. Sauce for the goose and all that. The point is you can’t confidently talk about 3.5 percent 10s without asking what that means for stocks. Or you shouldn’t.
Which, of course, brings up relative valuations. The spread between 10s and the S&P 500 dividend yield is about 60 basis points. If 10s were to rise 100 basis points and assuming that yield on the S&P 500 was steady, the spread would be 160 bp (check my math if you like). The 164 bps are the mean since 2000 and 14 bps are the mean since 2012! My point is: push 10s up and they look quite attractive to stocks surely. The 3.5 percent would be, I think, a gift next Christmas if 10s get there, but let’s not get too greedy. Again, I think we get 10s to 2.85 “percent-ish” and stall there in, more or less, the middle of the year. I also think that if all the factors mentioned in WSJ, and 13 million others, come to fruition, the risk is for a more aggressive Fed keeping prospects for a 100 to150 bp funds/10s spread a very unlikely prospect.
As an aside, there is a small worry that came up from various sources from a wonderful, if complicated, chart in the WSJ that I’ve attempted to provide here to an article in BBG ({NSN P2OEK46VDKHY
And the use? Well, buybacks and dividends continue to be the main thrust of it, according to various articles, surveys and comments. How much pressure it has on the shorter end of debt markets is, again, hard to decipher but it does mean at least potential selling and less buying. To the extent it’s used for buybacks and dividends it is obviously a good thing for the narrow scope of the companies that have all that cash.
David Ader is Chief Macro Strategist for Informa Financial Intelligence.
