Stocks caved into the decline in Treasury prices Tuesday afternoon as the yield on the 10-year Treasury note marched past 5.25%. Blame the world and Alan Greenspan.
After seesawing throughout the day, the stock market's attempts at recovery were undone as the 10-year eclipsed 5.25%, the level of the fed funds rate. The
Dow Jones Industrial Average
fell 130 points, or 1%, to close at 13,295.01. The
slid 1.1% to close at 1493 and the
fell 0.9% to finish at 2549.77.
The 10-year note ended the day down 23/32 to yield 5.26%, its highest level since 2002 and up from 5.13% Monday.
"The reason why bond yields have risen recently is the resolution of a contradiction that was in place over the first five months of this year," says Jack Malvey, chief global fixed-income strategist at Lehman Brothers.
The contradiction was interest rates below 5% in a world showing strong growth, a resurgent U.S. economy confirmed by robust equity returns and compressed credit spreads, commodities moving up, and richly priced risky assets, he explains.
"The world fundamental picture is bright here in mid-2007," says Malvey. The move in bond yields is about recognizing the global growth trend is up, and that easing from the Fed and other major central banks is, "for the near term, out of the question."
The markets awoke to news that reinforced Malvey's theory, and perhaps even pointed to more tightening around the world. Indeed, the
on-pause status stands virtually alone as other central banks remain in tightening mode, with a pause here and there, including the European Central Bank, the Bank of England, the Royal Bank of New Zealand, and in India, Japan and China, among others.
On Tuesday, China reported that inflation rose to 3.4% on a year-over-year basis, its highest level in two years and a development that may herald more tightening by China's central bank.
This data follows Monday's upward revision to Japan's first-quarter GDP to 3.3% from a prior estimate of 2.6%, which suggests the Bank of Japan also will be raising interest rates sooner rather than later. Monday's hawkish talk out of the Bank of England likewise
helped derail a stock market rally.
With tightening going on around the world, investors who have poured their resources into U.S. Treasury bonds suddenly see more yield in other nations' bonds, says William Hornbarger, fixed-income strategist at A.G. Edwards. And with many central banks diversifying their reserves into nondollar assets, old standby U.S. Treasury bond buyers are "not so insensitive to price."
He points to British two-year gilts, which yield around 5.84%, compared with our two-year note at 5.07%. "That's what people are thinking about," says Hornbarger.
Former Fed Chairman Alan Greenspan on Tuesday weighed in on the unwinding of what he once called the "conundrum," characterized by low long-term interest rates amid a rising fed funds rate. Much of the conundrum was facilitated by Asian central bank buying of U.S. Treasury notes to sustain favorable foreign exchange rates.
At a Commercial Mortgage Securities Association event in New York, Greenspan said he is not concerned about a wholesale dumping of Treasuries by foreign central banks, but warned that investors should not count on the liquidity punch bowl to exist forever.
"Enjoy it while it lasts," he said in the speech, according to wire service reports, also warning that credit spreads cannot remain tight and global economic growth cannot continue at its current pace. He referred to some price-to-earnings ratios as "discounting nirvana."
Indeed, global equity markets have been in a bull market since 2003, with the MSCI AC World index up 113% since then, writes Robert Buckland, global equity strategist at Citigroup.
Buckland believes any pullback due to the bond market's adjustment will be "buying opportunities," but acknowledges setbacks can snowball as investor panic spreads around the globe and investors reduce their risk.
"There is nowhere to hide when the setback comes," he writes. "Correlations
among different asset classes rise as equity investors de-risk on a global level. If you think there is a fall coming, move into cash. But don't forget to get back in again quickly or you will miss the ensuing recovery."
The message from most strategists is that the market may be seeing the start of a summer correction. But investors have yet to contend with any strategists lowering their targets for year-end.
Speaking of targets,
kicked of the spate of brokerages reporting second-quarter earnings Tuesday. The firm reported a 27% jump in profits for the second quarter, sending its stock as high as $78.19 intraday before settling up 0.5% at $76.06.
report earnings on Thursday. Shares of Goldman gained 0.3% on Tuesday, while Bear fell 1.6%.
Only three out of the 30 Dow stocks gained ground Tuesday,
With retail sales for May coming out Wednesday morning, the markets are bracing for another bout of volatility, but at least this one is based on local data.
In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click
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