Time to bail on bonds

Yields on the benchmark 10-Year Treasury are approaching 4%. Here's why they'll hit that level soon and keep climbing.

EMAIL  |   PRINT  |   SHARE  |   RSS
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)
By Paul R. La Monica, CNNMoney.com editor at large

Long-term bond yields fell as the Fed slashed interest rates to deal with the credit crunch. But with the market now focusing on inflation, yields are edging back towards 4%.

NEW YORK (CNNMoney.com) -- Long-term bond yields are edging close to 4%, a level they haven't touched since the end of last year. And some experts believe yields will only head higher in the coming months.

Bonds have sold off in the past few days, pushing yields on the benchmark 10-Year U.S. Treasury note higher, to about 3.9%. Bond yields and prices move in opposite directions.

The rise in bond yields is significant for several reasons.

For one, it's yet another sign that Wall Street is now worrying more about surging commodity prices and a weak dollar than a recession, weakness in housing and the credit crunch. Long-term yields tend to fall during economic slowdowns.

"One of the things driving yields higher is the fear of inflation. We have a weak dollar and you see that with gas and food prices," said Brian Battle, vice president with Performance Trust Capital Partners, a Chicago-based investment firm.

In addition, since mortgage rates and the rates for other longer-term loans tend to move in tandem with the 10-Year, a continued rise in Treasury yields should lead to higher mortgage rates.

So how much higher will bond yields go in the near-term? Battle said that he doesn't think a 4.5% yield on the 10-Year is out of the question.

He said that another factor that may drive yields higher is the expectation that the government may have to sell more bonds to compensate for lower tax revenue that is likely to result from the economic slump.

"Supply fears are an issue. We may have bigger deficits because of economic weakness. With lower tax revenue, more bonds being issued and higher inflation, yields will have to go higher to attract buyers," he said.

What's this all mean for the markets and economy? If rates keep heading higher, the Fed may finally get the hint from the bond market that it needs to worry more about inflation and less about recession.

"Growth prospects going forward aren't as dire as we might have thought a few months ago at the height of the financial crisis," said John Hendricks, senior vice president with Hartford Investment Management Co. "There has been no evidence lately to suggest the economy is going to fall off a cliff."

As I pointed out in yesterday's column, traders are starting to believe that the Fed's next move may be to raise rates and that the central bank might do so as soon as its October meeting.

"The bond market is hopeful the Fed has handled the recession fears and that they now won't devalue the dollar even more," Battle said.

It is also is worth noting that at the same time bond yields have been climbing, stocks have been steadily moving higher as well. So this could be a sign that the market's appetite for risk is increasing as investors flee "safe" assets like Treasurys for stocks, which tend to offer greater rewards.

What's more, with consumer prices up around 3.9% year-over-year, there's less reason to own bonds since the real yield (after subtracting inflation) is close to zero.

"The flight to quality to Treasurys has dissipated," said Hendricks. "Why do you want to hold a Ten-Year note yielding 3.9% when inflation is around 4%? Yields have to go to 4% if not higher in the next couple of months."

Issue #1 - America's Money: All this week at noon ET, CNN explains how the weakening economy affects you. Full coverage.

Are you buried under a pile of debt and need help getting out? Did you recently manage to pull yourself out of debt and want to share your story? Tell us about your experience with debt and how the current credit crisis is affecting you.. Send us your photos and videos, or email us to share your story.  To top of page

They're hiring!These Fortune 100 employers have at least 350 openings each. What are they looking for in a new hire? More
If the Fortune 500 were a country...It would be the world's second-biggest economy. See how big companies' sales stack up against GDP over the past decade. More
Sponsored By:
10 of the most luxurious airline amenity kits When it comes to in-flight pampering, the amenity kits offered by these 10 airlines are the ultimate in luxury More
7 startups that want to improve your mental health From a text therapy platform to apps that push you reminders to breathe, these self-care startups offer help on a daily basis or in times of need. More
5 radical technologies that will change how you get to work From Uber's flying cars to the Hyperloop, these are some of the neatest transportation concepts in the works today. More

Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.