What You Need to Know
- The decline in the 10-year Treasury yield is puzzling given the economic rebound and latest inflation reports.
- The rise in inflation reflects price increases in just a handful of sectors.
- The seemingly unrelenting rally in stocks is also led by a limited number of stocks and sectors.
“If you know what the 10-year Treasury is doing, you can predict all other markets,” says Brian Nick, chief investment strategist at Nuveen.
Ten-year Treasury yields are key for currency rates and in the stock market, the driving force behind which sectors will outperform and which won’t, according to Nick.
In the first quarter, when 10-year Treasury yields were rising, financials and energy stocks outperformed, reflecting higher inflation and inflation expectations as the economy accelerated. “It was off to the races,” said Nick.
By the second quarter, 10-year Treasury yields were falling, as concerns about a slowing economy and resurgence in COVID-19 infections due to the more contagious Delta variant grew. The so-called reflation trade retreated and tech stocks, REITs and health care securities outperformed.
The 10-year Treasury yield, which almost doubled in the first quarter from 0.92% to 1.74%, retreated to 1.25% in intraday trading on July 8 and 1.29% on the close. It has since rebounded to trade between 1.35% and 1.41%.
The Inflation Debate
What happens next to the 10-year Treasury yield and to U.S. stocks is uncertain not just because no one can be sure of the future but also because the decline in long-term rates doesn’t seem to fit an economy that continues to gather momentum.
“From a longer term perspective there is a big debate going on about inflation right now,” says Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research. “One camp says the Fed is being too lenient and is running the risk of letting inflation get too high which will result in the Fed having to slam on the brakes at some point.”
“On the other side are those that say the long-term factors holding inflation such as demographics of an aging population, declining trend in workforce, globalization, heavy debt levels, etc., mean that the overall trend is lower even if this is a temporary rebound in inflation,” Jones adds.
There are those like Bank of America Securities strategists who write in the latest research investment committee report (RIC) the “too-hot inflation” in Q2 and the “too-cold GDP” in Q3 that investors fear is creating “just-right conditions for equities & credit.”
What Long-Term Treasury Yields Are Signaling
Long-term Treasury yields are unusually puzzling this year. “How can it be in a quarter that grew by almost 10% annualized and had a stronger year-over-year core inflation number that long-term rates fell by close to 50 basis points from peak to trough?” asks David Kelly, chief global strategist at JPMorgan Asset Management.