The 10-year U.S. Treasury note is one of the most closely watched financial measures in the world. It’s hallowed status is up there with the U.S. dollar, the price of gold and the price of oil.
Many view it as a proxy for longer-term growth and inflation expectations and a thus signal for where the U.S. economy is headed.
The 10-year has been in the news in recent months because its yield — or what it pays its owner for buying it — has been flirting with 3 percent. Financial markets take a deep gulp when they hear the 10-year yield and 3 percent in the same sentence.
The big worry lately has been that the 10-year yield will cross 3 percent, making it a better investment than the riskier stock market. The thinking goes like this: Cross 3 percent and investors will stage a stock market sell-off and pour their cash into Treasuries.
And then? Bye-bye bull market.
“It’s a psychological level for the markets because we haven’t seen 3 percent 10-year yields since 2013,” said Brett Ryan, an economist with Deutsche Bank.
“The 10-year is potential competition for stocks,” said David Kass, a professor of finance at the University of Maryland.
Yield is a simple concept. It is the return you get for buying a financial instrument as measured by percent. You buy a bond for $1,000 and it pays you $100 upon maturity. That’s a 10 percent yield.
Money wonks believe the up-or-down movement of its yield is a crystal ball that foretells inflation, recession, bull markets, bear markets, home prices, corporate profits — maybe even who will win next year’s Super Bowl.
The level itself doesn’t signal recession. What matters is the difference between the two-year yield and the 10-year yield. Right now, the difference between them is about half of a percentage point. The risk of recession rises as the difference gets closer to zero.
The 10-year rate was within a dollar bill’s width of 3 percent Monday morning and landed at 2.973 percent by the late afternoon.
Wall Street watchers say the 10-year yield will have to climb beyond 3 percent before the stock market flinches.
“The 10-year Treasury would need to move over 4 percent before it became serious competition for the stock market, given the level of earnings per share we are currently seeing for the S&P 500 companies,” said Daniel P. Wiener of Newton, Mass.-based Adviser Investments. “By that time, if earnings are higher, then the yield would have to go even higher than 4 percent.”
Stock markets are not showing nervousness.
“There has been no flight to the exits out of stocks because the 10-year yield is going to 3 percent,” said David Santschi of TrimTabs, an investment research firm. “Equity flows have been roughly flat this month. People don’t seem really concerned that borrowing costs are rising.”
Stocks on Monday held firm in the face of the rising yield, with major markets finishing slightly down.
“It’s not like an automatic trigger for the stock market,” Ryan said. “Above 3 percent, it becomes more attractive to own, but it is still the risk-free asset. It’s not just the level of the yield, but the speed. If rates hang out around 3 percent, that’s fine. If we get to 3.25 next week, than that could bring dislocation to equity markets.”
There are tens of billions of dollars in 10-year treasuries across the planet at any given day, with banks, mutual funds and foreigners among the largest holders. The bonds are traded on the secondary market. The yields react to supply and demand, with yields rising when prices decline and yields dropping when the 10-year gets more expensive.
“The 10-year is very visible,” Kass said. ”Financial markets tend to focus on the 10-year rate as a form of long-term interest rates.”
If investors think that the economy and inflation will be agreeable enough over the next decade that they can park money in a 10-year Treasury, they will buy it. That demand will send yields lower. If, on the other hand, investors think we are headed for higher inflation and a rocky economy, they will put their money into short-term Treasuries rather than long-term. That reduces demand and the prices drops, sending yields higher.
The 10-year’s stature as a benchmark comes from being risk-free, which makes it the one asset to which all others — stocks, bonds, mortgages, etc. — are pegged. Stocks are riskier, so they have a higher expected return with capital gains and dividends than Treasuries.
Treasuries are risk-free because it is backed by the U.S. Government and its ability to tax. Stocks and corporate bonds can fail.
Three percent is viewed as a key threshold for a number of reasons. But the main reasons are mortgage rates, the stock market and corporate debt.
“Mortgage rates are closely linked to the level of the 10-year yield,” said Ryan. “If the 10-year ticks higher, mortgage costs are going to go higher. That impacts the housing market and it’s one of the main channels the 10-year yield translates into the real economy.”
Higher yields also foretell higher borrowing costs for corporations, which can cut into profits and investment. The result can be a cascade of layoffs, stagnant growth, recession and lower stock prices.
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