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The long term descent of US bond yields is one of the financial market backdrops that has been taken for granted. It is a bit like air - you only really miss it when it suddenly isn’t there.
The recent rise in bond yields has drawn a lot of attention to the possibility that this decade long stretch may be over. Looks like the ultimate battle between deflation and inflation will be settled sooner than we thought.
It is still a bit too early to dance on the grave of the great bond bull market. We’ve been here before more than a few times. As you can see from the long term chart above, the trendline has held firm and pushed back the yield lower again and again. The blue line is the (really long term!) 100 month moving average and it has also acted as a pseudo trendline.
Another interesting observation is that with the exception of the case in 1995, whenever the 30 year T-Bond yield has approached the down trend line the S&P 500 has crested and fallen much lower. It isn’t a complete history and could be just a data mining coincidence but the equity market topped in: mid-1990, 2000 and 2007.
Not surprisingly, Ned Davis Research is also keeping a wary eye on the bond market for this very reason. They believe that a jump above 4.25% (for the 10 year) will send a shudder through the equity market. And a spike above 5.25% would mortally wound the cyclical bull market.
Actually, as NDR points out, the S&P 500 index and the 10 year T-Bond rate have demonstrated a surprising amount of correlation in the past few years. Here’s a chart comparing the S&P 500 index for the past few years with the 10 year US T-Bond yield :
David Rosenberg wrote recently:
…the front page of the Sunday NYT runs with “U.S. Consumers Face End of Era of Cheap Credit“. When the view of higher interest rates comes to dominate the media as much as it has in recent days, you know that something else is bound to happen. That NYT article stated that housing “has only recently begun to rebound” — well, when you look at the chart of new home sales, housing starts and the NAHB index, it’s very difficult to detect any rebound at all…
One reason why interest rates cannot rise is because if they do, there will never be a sustained improvement in the pace of economic activity. Housing is the classic leading indicator, and the most interest-sensitive sector, and until it revives, it seems highly unlikely that bond yields will rise on any sustained basis or that the Fed will embark on a path towards higher policy rates.
My own hunch is that the consequence of any potential rise in rates depends not on any magical nominal level but how fast we get there. If rates rise with a ’stealth’ bear market in bonds, that would be one thing. If they suddenly go haywire, the way we’re seeing, for example, in Greece… that would be a very different thing.
Finally, I hope that by now we’ve put behind us the myth that rising interest rates are bad for the stock market. The effect on on mortgage rates isn’t that difficult to imagine. Any any nascent real estate recovery would be crushed by a rapid jump in rates and with it any positive consequences of a “wealth effect” from higher real estate prices. For more, see Shiller’s recent column: Don’t Bet the Farm on the Housing Recovery in the New York Times.
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