Surge in Bond Yields Seen as Sign of Revival

The economic numbers may be murky, but many bond investors worldwide seem to have made up their minds: There is going to be a recovery in the second half of this year.

That’s apparent from the surge in long-term bond yields in recent weeks in the United States, Japan, Germany and other major economies.

At the same time, stock markets mostly have been shaking off the jump in rates. That is another strong sign of faith in an economic rebound.

On Wall Street, the yield on the benchmark 10-year Treasury note rose to an eight-week high of 3.65% on Thursday from 3.54% on Wednesday, despite a decidedly bearish June employment report. (U.S. financial markets were closed Friday for the Fourth of July holiday.)

Bond yields in Britain and Germany also surged to eight-week highs this week.

U.S. and European yields snapped back, briefly, in March as well. What’s different this time is that interest rates in long-suffering Japan, the world’s second-largest economy, also have risen sharply. The 10-year Japanese government bond yield Thursday hit the highest level since October after a midweek report showing greater business confidence in the second quarter.

“Bond investors sense that a definitive turn in the business cycle has arrived,” said Jack Malvey, fixed-income strategist at brokerage Lehman Bros. in New York.

If business activity picks up, so too should demand for money. Inflationary pressures also might build. Either or both of these shifts could push up longer-term interest rates. So some bond investors are heading for the exits now, making higher yields a self-fulfilling prophecy.

Another sign of investors’ sudden skittishness about bonds: Auctions of long-term government securities in Germany and Japan this week attracted the fewest bids since July 2000 and September 2002, respectively, according to Merrill Lynch & Co.

What’s bad for bonds, however, could be good for stocks. An economic revival would be expected to boost corporate earnings. That’s why some investors are trading bonds for stocks. Even as bond yields rose this week, Japan’s Nikkei-225 stock index rocketed 4.9%, the U.S. Standard & Poor’s 500 index gained 1% and the main German stock index was up 0.5%.

Economist David Rosenberg at Merrill Lynch in New York calls the bonds-to-stocks switch “a giant global repositioning trade” by big investors.

Investors could be premature in betting on a turnaround. Recent economic data have been mixed at best. On Thursday, for example, the Labor Department said the unemployment rate rose last month to a nine-year high of 6.4%, dashing hopes that hiring had begun to improve.

On Friday, the German government said factory orders fell a worse-than-expected 2.2% in May from April.

But other reports have been encouraging. In Japan, the more upbeat business confidence report Wednesday was followed Friday by a government announcement that the nation’s index of leading economic indicators rose in May from April’s level.

In the U.S., a corporate trade group said Thursday that its index of service-sector activity in June soared to the highest level since September 2000.

In part, the recent uptick in bond yields reflects that some investors are giving up on the worst-case scenario: that the global economy might teeter back into recession and that deflation -- a sustained and broad decline in prices -- would break out worldwide.

Those fears had helped drive bond yields in the U.S., Japan and other countries to generational lows in mid-June as investors rushed to lock in yields. The 10-year U.S. T-note bottomed at 3.11% on June 13.

The Federal Reserve helped to disperse some of the gloom about the economy when it chose to cut its key short-term interest rate by a quarter-point on June 25, to 1%, instead of by the half-point that many bond investors had been expecting.

Japan’s central bank, meanwhile, hinted in mid-June that it was concerned that investors had gone too far in pushing that nation’s benchmark bond yield to a record low of 0.45%. The yield has since doubled, to 1.06%.

Yet many Wall Street pros say a number of factors should limit bond yields’ upside this year -- which in turn could help keep mortgage rates from zooming. The average 30-year U.S. mortgage rate rose to a seven-week high of 5.4% this week from 5.24% last week.

Major central banks’ maintenance of low short-term interest rates should have a restraining effect on longer-term rates, experts say.

“Fed officials will be extremely slow to tighten monetary policy” even if economic data continue to improve, economists at Goldman Sachs & Co. said in a report Thursday, echoing the majority view on Wall Street.

They predicted that the Fed would keep its key short-term interest rate at the current 45-year low until at least 2005.

With inflation subdued, Lehman’s Malvey said, global investors’ appetite for bonds will intensify as yields rebound, which also would have a restraining effect on rates.

The 10-year Treasury note yield might reach 4.25% by year’s end, Malvey said, but even at that level the rate would be lower than at any time in the 1990s.

And as long as yields are rising because the economy is turning up, the stock market should be able to withstand higher interest rates, many analysts say.

“There is no evidence yet that this global run-up in bond yields is standing in the way of a better tone in equities,” Merrill’s Rosenberg said.

“If people see the economic tide coming in,” said James Glassman, economist at J.P. Morgan Chase & Co. in New York, “it’s going to give the stock market a lift.”