Investors this week have been focused on a sharp move higher in Treasury yields, raising concerns about rising interest rates at a time when the economy is desperately trying to recover from the effects of the pandemic.
The benchmark 10-year Treasury yield (^TNX) hovered around 1.36% for its highest level in a year, after wallowing below 1% for most of 2020. Suddenly, investing in government bonds is beginning to look more attractive for the first time in months, but market strategists say it is the speed at which yields have increased, rather than their level, that pose the biggest threat for stocks.
“Yields are rising, but the pace of the rise is not fast enough now that I think it would cause trouble,” Tom Essaye, founder and president of Sevens Report Research told Yahoo Finance Live. “We’re not at taper tantrum levels yet. And the absolute level of yields is still low enough that I think stocks can get more volatile.”
“Taper tantrum” refers to the 2013 market panic that triggered a spike in U.S. Treasury yields after the Federal Reserve said it was slowly putting the brakes on its quantitative easing (QE) program. In the end, investors’ worries were unfounded, as the bull market continued even after the tapering began.
While history has shown that the equities market can tolerate higher yields, Ellen Hazen, portfolio manager and principal at F.L. Putnam Investment Management, agrees with Essaye. She said what tends to derail stocks is when yields increase rapidly.
“So if we saw a 150 basis point increase from here in the 10-year inside of a six-month window that would be fairly alarming and that would derail stocks,” she said. “But if we see a gradual increase in the 10-year bond going forward, that could be very constructive for the market. So there’s no absolute level. It has much more to do with the speed with which rates increase.”
Some analysts believe the rise in bond yields is overdue, since it reflects stronger economic growth.
“We think that bond yields are rising because inflation expectations are growing and also because growth expectations are growing and those are both generally good indicators for stocks,” Hazen told Yahoo Finance Live.
Hazen said when economic growth rises along with inflation you want to “own stocks that have pricing power” such as interest rate sensitive bank stocks.
“With banks trading at under two times book value— and in some cases close to one times book value— for high single digit to low double digit ROEs (return on equity), we think banks are very good areas to own in a steepening yield curve environment,” said Hazen.
Federal Reserve Chairman Jerome Powell on Tuesday once again reiterated the central bank’s commitment to keeping interest rates low and continuing large-scale asset purchases until the economy has recovered further from the effects of the pandemic.
“The economy is a long way from our employment and inflation goals,” Powell said in testimony to the Senate Banking Committee.
Essaye said the Fed’s support of the economy will continue to be a positive for stocks. “What the Fed would do, is they would buy 10-year Treasuries, instead of, say, two- or five-year treasuries, to try and push down the yield. They won’t stop the rise, but they can slow it down.”
Essaye said we could see market volatility if yields reach 1.6% to 1.8% in the next couple of weeks, but he believes the market could easily absorb yields of “well over 2%” on the 10-year Treasury. “I don’t think it ends the bull market, but I think that could cause a temporary pullback,” he said.
Alexis Christoforous is an anchor for Yahoo Finance. Follow her on Twitter @AlexisTVNews.
