“Sentiment [on treasuries] has probably gotten too bearish given the current set of news.”
– Tony Crescenzi (subscription required), Chief Fixed Income Strategist, Miller Tabak
The sell-off the last three days has been entirely about interest rates. Higher interest strain consumers with credit card debt and adjustable rate mortgages. It hurts the housing market by making mortgage payments more expensive for potential buyers. It hurts corporations and private equity companies who want to borrow money to acquire companies. So there’s good reason that rising interest rates cause stocks to sell off.
That said, the current “melt up” in interest rates seems a bit excessive. The yield on the 10 year treasury has risen 25 basis points in the last 5 trading sessions! That’s right: it closed last Thursday 5/31 at 4.89% and closed today at 5.14% – according to the WSJ Markets page.
What’s happened in the last 5 sessions to cause such a huge sell off (and corresponding raise in rates)?
The first big event was the May Jobs Report on Friday 6/1. Non farm payrolls surged 157,000 – ahead of economist’s consensus expectations of 135,000 – and the yield on the 10 year surged 7 basis points to 4.96%.
The next big day was Tuesday when the ISM services sector report came in stronger than expected and Bernanke held to his line about housing having no spillover effects and the economy on track for moderate growth. Yields on the 10 year rose 6 points to 4.99%.
A line was drawn in the sand: 5% on the 10 year. Would it hold?
And today we got our answer: No!!!!
I don’t know if it was the somewhat strong retail chain store sales report that showed chain store sales up 2.5% (subscription required) from last May, or the Bank of New Zealand raising its target interest rate or what.
Whatever it was, interest rates shot up with the 10 year yield blasting through 5%, spiking 17 basis points to close at 5.14%.
Towards the end of the session, the world’s biggest, and one of the most respected, bond manager, Bill Gross, said that he’d turned bearish on bonds after being bullish for 25 years. The market, seeming to have stabilized down a little more than 100 points headed sharply south again, finishing down 199 points.
The question we all have to ask is: is this rational? And: how far can it go?
To take a stab at the first question: No. It seems to me that the move is all about a re-calibration of Fed expectations. If that’s right, then there are limits to how high rates can go in the short term because the Fed is on hold at 5.25%. People are starting to talk about rate hikes but that’s just speculation. What the Fed does is going to depend on the evolution of the data on economic growth and inflation – as they always end their policy statement saying.
The one thing I worry about with interest rates is Asian central banks. Because of our huge current account defecit, Asian central banks are in posession of an enormous amount of US government debt. Should they make a decision to diversify into other countries assets, gold, Blackstone, or whatever, that selling could cause a substantial spike in US interest rates. (On this important topic, I highly recommend Richard Duncan’s “The Dollar Crisis”, an eye opening book explaining the structure of the current global economic system that can best be described as surreal).
Is this what is causing the current spike? It’s possible but it doesn’t seem like it to me. I think it’s the former reason: recalibration of Fed expectations. But if I’m wrong, then this has alot more legs than I am currently suggesting.
Now then to our second question: how far can it go? Pretty far. “Markets can stay irrational longer than you can say solvent” is an oft quoted line from John Maynard Keynes.
If people are convinced rate cuts are off the table and rate hikes likely, yields on the 10 year could certainly head up towards 5.5% – the next destination were the Fed to hike.
As always, the only thing we can do is pay close attention to how (and why) things play out and adjust accordingly.