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Rising Yields on Treasuries Challenging Stock Bulls

November 05, 1998|TOM PETRUNO

It's a good thing the election worked out mostly to the stock market's satisfaction, because it distracted investors from a brewing problem: a rebound in interest rates.

Yields on U.S. Treasury securities, which plunged in early October amid a global "flight to safety," had been creeping higher recently. And in the last few days they've gone into rocket mode.

The 30-year T-bond yield, which hit a generational low of 4.72% on Oct. 5, leaped to 5.33% on Wednesday from 5.21% on Tuesday and is the highest since Sept. 8.

At the short end of the interest rate spectrum, the three-month T-bill yield soared to 4.57% on Wednesday from 4.50% on Tuesday. It was at 3.62% as recently as Oct. 16.

The stock market has gamely ignored resurging Treasury yields in recent weeks, choosing to look on the bright side of things: The global financial panic that was largely responsible for those super-low Treasury yields earlier this month has subsided.

But on Wednesday, the retreat of panic translated into a dismal auction of new 10-year T-notes by the Treasury. Uncle Sam was able to sell $12 billion worth, but demand was poor, which forced the government to pay a higher-than-expected 4.825% yield.

That triggered heavy selling of Treasury securities across the board late Wednesday--which, for a while at least, got the stock market's attention: The Dow Jones industrial average had been up as much as 148 points before pulling back, then rallying again to finish up 76.99 points at 8,783.14.

James Bianco, head of Bianco Research in Barrington, Ill., notes that for months now "the bond market has been the inverse of the stock market": When bonds have done well (i.e., yields have fallen), stocks have slumped; now, as yields rise, stocks are rallying.

Normally, that would be counterintuitive. Falling rates are supposed to be good for stocks, and rising rates are supposed to be bad.

But the economic scare of August and September--the fear that the global economy was headed for depression and deflation--turned the normal stock-bond relationship on its head.

Falling Treasury yields were a sign that investors were scared witless and were buying the only security they felt was 100% safe.

Now, the resurgence in Treasury yields (and thus the relative decline in demand for those securities) says people are willing to invest in riskier securities again. As bond pro Tad Rivelle at Metropolitan West Capital Management in Los Angeles puts its, "People are willing to perceive [again] that the world is a going concern."

But the return of that perception has been spurred in large part by the Federal Reserve Board's decision to cut its benchmark short-term interest rate, the federal funds rate, twice since Sept. 29.

How do now-rising Treasury yields jibe with falling Fed rates?

For one, even as Treasury yields have jumped, they're mostly below the 5% federal funds rate. Which suggests the market believes the Fed has more cutting to do--perhaps as soon as its Nov. 17 meeting.

Some Wall Street pros believe the Treasury market is simply facing some indigestion right now. William Griggs, at bond consulting firm Griggs & Santow in New York, argues that the current supply "glut" of Treasuries will become a shortage in a few weeks, as the Treasury completes its quarterly refinancing, which ends with a 30-year bond auction today.

"I think we're going back down again" in terms of yields, Griggs said, as investors assess the probability of additional Fed rate cuts, a potentially weaker economy and limited Treasury borrowing amid the government's surplus.

"I think this is a money-making opportunity," Griggs said of current Treasury yields.

Stephen Slifer, economist at Lehman Bros. in New York, believes the economy will be so weak in 1999 that 30-year T-bond yields will fall to 4% by mid-1999.

But some bond managers aren't so sure. Rivelle wonders whether the surprise could be that the economy is healthier than expected in 1999, causing the Fed to balk at many more rate cuts.

In any case, he thinks the better buys today for bond investors are corporate bonds. Yields on many corporate bonds had rocketed in September and early October as investors fled from risk.

In recent weeks, corporate yields have declined a bit even as Treasury yields have jumped, Rivelle notes--which reflects investors' renewed optimism about avoiding recession or worse.

But can the stock market ignore rising Treasury yields indefinitely? History suggests not. Which places the ball back in the Fed's court: With another rate cut Nov. 17, the central bank probably could calm the bond market and boost the stock market even more.

But if the Fed balks at another cut, the fireworks in both markets could be spectacular.


Tom Petruno can be reached by e-mail at


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Short- and long-term U.S. Treasury yields have rebounded sharply from their recent lows. Yields on 3-month T-bills and 30-year T-bonds, weekly closes and latest:

3-month T-bill: 4.57%

30-year T-bond: Wednesday--5.33%

Source: Bloomberg News

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