Treasurys are surging as stocks get slammed

Chelsea West
February 10, 2018

US Treasurys are surging as heavy selling briefly pushed the Dow Jones industrial average down more than 1,500 points.

It has now done that twice in four days. But such calm is unusual, and stocks overheated. Then on Thursday, a block trade of put options targeted the 30-year yield to rise to 3.25 percent by February 23, from about 3.15 percent now. The broader Standard & Poor's 500 index and the technology-focused Nasdaq composite closed Thursday near correction levels as well.

Rory McPherson, head of investment strategy at Psgima IM, said investors should expect more volatile markets heading into 2018, as this is the first year where the marginal buyer of bonds is not a central bank. Unemployment is historically low, and there are more open jobs than people to fill them. A stronger economy generally strokes inflation. During the years in which the Fed held interest rates near zero, safety-seeking long-term investors were forced to buy riskier assets to meet their return targets.

"10-year Treasury yields will remain under 3% by the end of the year, which is a good environment for equity markets". Thursday's decline was 4.2 percent.

The S&P 500 ended down 3.8 per cent and the Dow finished down 4.2 per cent.

A little more than a week into the New Year, billionaire bond guru Bill Gross proclaimed the start of a bond bear market, after an extraordinary bullish run spanning more than three decades.

Benchmark 10-year Treasury yields touched 2.88 percent Thursday, once again brushing up against the highest level since 2014, even as stocks plunged anew.

"All of a sudden, investors as a group realized that the risk is there, and they're adjusting price to reflect that", he said.

At prevailing bond yield of 7.56 per cent, one would then require 13.56 per cent (adding 6 per cent risk premium) on equity to make a switch from bonds.

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Fears of inflation linked to a falling dollar are driving up bond yields and fueling expectations of potentially four interest rate hikes from the Fed this year. The compromise, coupled with Republican tax cuts, could lift the federal budget deficit to $1.07 trillion in fiscal 2019, according to Bank of America estimates.

Next week, coming off one of the most volatile stretches in years, two important readings on USA inflation could help determine whether the stock market begins to settle or if another bout of volatility is in store. Bond yields are rising as the Federal Reserve trims its USA bond holdings.

Wall Street is clearly trying to figure out whether this is the big one as the Fed gradually pushes official borrowing costs higher.

"The U.S. economy is on solid foundation", said ClearBridge's Schulze. "In fact, I think some of the market reaction is to the fact that the economy is doing well".

Some stock strategists say the stock market may have found a near term bottom Wednesday but the volatility is expected to continue. But it certainly prompts central banks to take monetary action, which reduces liquidity in the system.

The 10-day correlation between the S&P 500 index and yields on the 10-year note stands at a negative 0.79. Rising bond yields, he notes, are a sign of economic strength. Almost 80 per cent of companies that have reported so far this earnings season have suprised analysts to the upside. But if inflation picks up, the Fed could raise rates more often or more steeply than it had planned. For years after the financial crisis, they could count on Ben S. Bernanke and Janet Yellen to essentially limit how far prices can fall in financial markets - colloquially referred to as a "put", after the option.

Before the recent downturn began last week, the Dow had gone 417 days without a 5 percent drop, the longest such stretch since 1928, Ewing said.

In recent times, India's equity indices rallied to record high levels despite a steady spike in bond yields.

Other reports by TheSundaySentinel

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