TOKYO—Japan’s finance ministry plans to boost government bond issuance by $75 billion to fund an economic stimulus package, potentially stoking concerns about the nation’s fiscal health.
Prime Minister Sanae Takaichi’s cabinet on Friday approved a draft supplementary budget for the fiscal year ending March 2026 that is worth 18.303 trillion yen, or about $117.10 billion. The government now plans to issue an additional 11.696 trillion yen of bonds, including increases in issuance of two- and five-year notes.
Britain’s stock and bond markets flopped Friday morning on new evidence that the country’s Labour Party leadership doesn’t have a clue what to do about the economy or budget. Add this to the list of welfare-state cautionary tales out of Europe.
At one point Friday morning, the yield on the benchmark 10-year government bond, or gilt, had risen 11 basis points to 4.55%. The main London stock index dipped nearly 2%, and the pound fell. This was in response to a Financial Times report Thursday night that Chancellor of the Exchequer Rachel Reeves is abandoning plans to increase income-tax rates in her budget plan this month.
This sounds like good news. but investors interpreted it as a sign that Ms. Reeves and her boss, Prime Minister Keir Starmer, have run out of politically viable ways to balance the government budget—which is true. Estimates of the budget “black hole” Ms. Reeves needs to fill range up to £30 billion per year—the gap between likely spending and revenue if current policies stay the same.
An attempt over the summer to cut some particularly generous welfare benefits collapsed amid a rebellion from Labour backbenchers in Parliament, putting welfare reform off the table. Mr. Starmer is rightly under pressure to increase defense spending. Labour’s promises of economic growth via public “investment” translate mainly to pay increases for government workers.
Argentina’s stocks, bonds and currency surged Monday after the country’s midterm elections delivered a surprising mandate for President Javier Milei to press ahead with his free-market economic overhauls.
The Argentine peso rose around 9% against the U.S. dollar in midmorning trading, the most in more than two decades. A U.S. dollar-denominated government bond maturing in 2046 rose by 11 cents to trade at 66 cents on the dollar, according to Tradeweb data. Argentina’s benchmark stock index, the Merval, was up 17% as bank stocks soared.
Bond traders are at it again, pushing Treasury yields higher and signaling the Federal Reserve was too heavy-handed when it cut interest rates by a half-percentage point last month. The recently rising yields have put pressure on the stock market — and specifically, names in our portfolio tied to housing. The 10-year Treasury yield — which influences all kinds of consumer loans, including mortgage rates — rose again Wednesday, reaching a session-high 4.26%. That’s a level not seen since late July when the yield had started to turn lower in anticipation of the Fed rate cut, which came on Sept. 18. Since then, though, the 10-year yield has been working its way higher. On the shorter end of the yield curve, the 2-year chart follows a similar pattern. US10Y US2Y 3M mountain Three month performance The hope when the Fed started cutting rates was that shorter-duration Treasurys would move lower at a greater pace than longer-dated ones, providing relief to borrowers and investors. That’s not what has been happening lately. The 2-year and 10-year yields have recently been moving higher together. Rates are like gravity for stocks — the higher the rates, the greater the competition for investment dollars. Elevated, risk-free government bond yields become an enticing way to get returns when compared to the volatility of stocks. A higher 10-year Treasury yield also halts relief on mortgage rates. The average 30-year fixed-rate mortgage, while more than 1 percentage point lower than a year ago, has moved higher three weeks in a row. In Freddie Mac’s latest weekly survey , the 30-year fixed rate was 6.44%. The Fed cutting rates represents an easing of monetary policy, which allows the economy to grow quicker and easier and makes debt more affordable. The downside of those dynamics is that a hotter economy also raises the prospects of sparking inflation again, just as it has started to moderate. Bond traders are worried about rekindling inflation because economic numbers have been coming in stronger since central bankers met in September. The market odds on a quarter-point Fed cut next month remain basically a lock, according to the CME FedWatch tool . But after that, the chances of a December cut are dwindling. A troublesome rebound in inflation, however, is not what we’re calling for, and it’s not what we’re basing the Club’s investment decisions on. Another dynamic pushing bond yields higher is concern over what happens to the national debt and trade deficit under a new presidential administration. Whether the move up in yields is a bet on next month’s election or reflects a that view that regardless of who wins, fiscal policy will remain loose, is anyone’s guess. Both presidential candidates do seem to agree on one thing: The cost of living is too high. A large, unavoidable line item on consumers’ balance sheets is housing costs, which have been one of the stickiest areas of inflation. For home prices to come down, we need more housing supply and lower mortgage rates to incentivize builders and to motivate sellers and buyers. Lots of would-be sellers are sitting on historically low mortgage rates and are reluctant to move, which drives home prices higher. Would-be buyers are reluctant to pay those higher home prices on top of elevated mortgage rates. Increased housing formation based on the Fed lowering rates is key to our investment cases for three stocks in the Club portfolio: Stanley Black & Decker , Home Depot and Best Buy . The bond yields rising and mortgage rates creeping up have pushed back the benefits of the Fed’s easing, as we explained in Tuesday’s small addition of more Home Depot shares. Ultimately, however, fighting the Fed has proved a fool’s errand in the long run — so, we do expect rates to eventually come down. In addition, the management teams at Stanley Black & Decker, Home Depot and Best Buy are executing effectively on the things within their control. Sure, they will benefit from lower rates — but rates alone are not why we own positions. We’re in them because the fundamentals are improving, which will only come further into focus when rates come down. Bottom line The rise in bond yields is not sustainable, in our view, because shorter-duration Treasury yields are bound to come down if the Fed applies enough pressure. The longer end of the curve should then come down and provide the needed relief on mortgage rates. When that happens, you will want to already have the rate-sensitive stocks on the books. We may have been early. But we’re ready. To give up on these names now, right when the Fed has broadcasted that the rate-cutting cycle is in effect, would be a mistake. By the time it becomes clear that the 10-year yield has peaked, you will likely have missed a significant part of the move. (Jim Cramer’s Charitable Trust is long SWK, HD, BBY. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.
Cars drive past the Federal Reserve building on September 17, 2024 in Washington, DC.
Anna Moneymaker | Getty Images News | Getty Images
Bond traders are at it again, pushing Treasury yields higher and signaling the Federal Reserve was too heavy-handed when it cut interest rates by a half-percentage point last month. The recently rising yields have put pressure on the stock market — and specifically, names in our portfolio tied to housing.
Among the illustrious nameplates adorning the offices of Ivy League business schools is one Joao Gomes. A Wharton Business School finance professor, Gomes is issuing a warning cry many of his peers so far have chosen to ignore: America’s burgeoning public debt mountain.
Professor Gomes is what some might call up-and-coming: He was appointed senior vice dean of research in 2021, adding University of Pennsylvania’s Marshall Blume Prize to his CV in 2018.
But the fresh-faced expert isn’t afraid to step away from the pack if it means pushing presidential hopefuls for some answers. Gomes admits he’s “probably” more worried than his colleagues about government debt, but refuses to stay silent on a broiling issue he believes will throw the global economy into disarray.
Gomes predicts America’s $34 trillion debt burden may upset the world’s financial markets as early as next year—should a president-elect announce a raft of expensive policies.
And remember the UK’s mortgage meltdown following a disastrous premiership under Prime Minister Liz Truss? That’s on the cards as well, as Gomes said rates could spiral to 7% “or higher” if the topic is swept under the rug by Washington.
But despite this, presidential candidates likely won’t be getting on stage with promises of how they’ll wrestle down the debt-to-GDP ratio to a more palatable figure (experts are currently predicting it will reach 190% by 2050.)
“I wish it was a big issue but I’m not sure it’s in the interest of either party to make it a big issue,” Gomes told Fortune. “As we discuss promises about: ‘What we’re going to do with tax and programs’ it’s going to be important to put it in the context of: ‘Can we afford that?’”
“It’s a really obvious moment in history for us to say: ‘OK, what are our choices, what can we feasibly do, who has the better plan?’ I suspect neither party is interested in that and it might all be pushed under the rug.”
I probably worry about the US debt more than most of my professional colleagues. But in this election year I believe voters should ask much tougher questions of politicians that don’t take this threat seriously. https://t.co/TDMDbCssVi
Indeed, while one party will have to make some unpopular decisions to tackle the issue, it’s a problem created by both of them. Bank of America Research’s Flow Show team, led by investment strategist Michael Hartnett, calculated in February that the deficits run up under the tenures of Presidents Trump and Biden are the greatest since Franklin D. Roosevelt in the 1930s.
Trump and Biden both dealt with a crisis-struck economy trying to navigate a global pandemic. FDR, of course, was firefighting the Great Depression and then oversaw the American entry into World War II.
Gomes believes that irrespective of who contributed to the mess, one party is going to have to shoulder the responsibility for unpicking it: “Toward the latter part of the decade we will have to deal with this.”
“It could derail the next administration, frankly. If they come up with plans for large tax cuts or another big fiscal stimulus, the markets could rebel, interest rates could just spike right there and we would have a crisis in 2025. It could very well happen. I’m very confident by the end of the decade one way or another, we will be there.”
Warning signs
As with any financial crisis, there will be warning signs when the national debt comes home to roost—though for consumers and markets this realization may not happen in synchrony.
At a policy level, Gomes believes, this will be when the parties buying debt decide the model is simply no longer sustainable. This could even be triggered by government policies announced early in the next administration, which in turn will spook a market seeing a hefty price tag attached.
“The most important thing about debt for people to keep in mind is you need somebody to buy it,” Gomes told Fortune. “We used to be able to count on China, Japanese investors, the Fed to [buy the debt]. All those players are slowly going away and are actually now selling.”
The nations most exposed are Japan, which owned $1.1 trillion as of November 2023, China ($782 billion), the U.K. ($716 billion), Luxembourg ($371 billion), and Canada ($321 billion).
“If at some moment these folks that have so far been happy to buy government debt from major economies decide, ‘You know what, I’m not too sure if this is a good investment anymore. I’m going to ask for a higher interest rate to be persuaded to hold this,’ then we could have a real accident on our hands,” Gomes said.
In this case, Gomes believes America would see something of a Liz Truss-like implosion. In 2022, the British MP backed a mini-budget featuring a raft of fiscal stimulus, spooking the City to the extent that the pound spiraled to its lowest value ever against the dollar.
After the shortest premiership in British history, Truss was promptly ousted, but not before leaving a legacy: British mortgage rates increased by approximately 2% in a matter of weeks.
And following this trend, mortgages—a cornerstone of Western economies—are precisely where consumers will start to feel the heat. When mortgage rates go above 7% is when consumers will start pushing for change, said Gomes, adding that if policymakers don’t take steps now the public will be back to these rates, “if not worse.”
Avoiding exposure
The good news is, there are a couple of ways to avoid this crisis. The bad news is, nothing at all needs to happen for government debt to become the economic issue of the next decade—and it’ll be pretty unavoidable once it gets here.
And if you’re wondering how much debt the government would need to recoup per person, it’s not pretty: current estimates are that it’s over $100,000 for each individual.
The route to avoiding this problem sounds simple: After all, if the debt-to-GDP ratio is what’s got everyone so concerned, just upping the second variable will rebalance it, right? Yes, but it means growing the economy pretty swiftly, and few are convinced America can do that.
The second solution is unpopular, but may be the only alternative the government is left with: Cutting spending. “Responsible budget proposals” may suffice to stave off any market upset, Gomes said, while “imposing major cuts on some programs … opens a Pandora’s box of social unrest that I don’t think anybody wants to think about.”
If markets do indeed rebel across the globe and throw the world’s largest economy into disarray, the ripple effects will be felt across borders. Unfortunately, Gomes believes there will be no avoiding it: “A government that runs into funding difficulties, that cannot convince investors to fund its debt, that government is going to probably have to raise taxes. There’s no way you can protect yourself from that.
“Any exposure you have, whether it’s mortgages or loans, is really hard to avoid in any dimension. It’s bad across the board for the country but it’s hard to avoid exposure wherever you live in the world.”
US President Joe Biden, with Treasury Secretary Janet Yellen, speaks during a meeting with his cabinet at the White House in Washington, DC, on March 3, 2022.
Jim Watson | AFP | Getty Images
The U.S. government ran up another half a trillion dollars in red ink in the first quarter of its fiscal year, the Treasury Department reported Thursday.
For the period from October 2023 through December 2023, the budget deficit totaled just shy of $510 billion, following a shortfall of $129.4 billion in just December alone, which was 52% higher than a year ago. The jump in the deficit pushed total government debt past $34 trillion for the first time.
Compared to last year, which saw a final deficit of $1.7 trillion, 2024 is running even hotter.
In the first quarter of fiscal 2023, for example, the difference between spending and receipts totaled $421.4 billion. On an unadjusted basis, that’s an increase of $89 billion between fiscal 2024 and last year. Adjusted for calendar factors, the Treasury Department said the change between the two years is actually $97 billion. December’s shortfall was higher by more than $34 billion compared to the previous year, driven by higher Social Security payments and interest costs.
If the current pace continues, 2024 would end with a deficit of just more than $2 trillion.
The deficit has continued to pile up despite the Biden administration’s assurances that the Inflation Reduction Act, in addition to reducing prices, would shave “hundreds of billions” off the deficit.
While the rate of inflation has come down, Labor Department data Thursday showed the consumer price index increased another 0.3% in December, pushing the 12-month rate up to 3.4%, higher than the Wall Street consensus and above the Federal Reserve’s 2% goal.
With interest rates elevated as the Fed fights inflation, financing costs for the government in 2023 totaled nearly $660 billion. Debt as a percentage of gross domestic product rose to 120% in the third quarter of 2023.
Inside the $26 trillion Treasury market, perhaps the deepest and most liquid place for government debt in the world, a particular trade continues to draw scrutiny ahead of year-end. It’s the “basis trade,” a way of profiting on the differences in prices between Treasurys and Treasury futures. While such differences can be relatively tiny, one’s potential profit or loss can be exponentially magnified when leverage is involved.In a nutshell, the basis trade takes an arbitrage approach: It involves borrowing from the repo market for leverage and financing, and then taking a short Treasury futures position and a long Treasury…
In the U.S., 516 publicly listed firms have filed for bankruptcy from January through September 2023. Many of these firms have survived for several years with surging debt and lagging sales.
“The share of zombie firms has been increasing over time,” said Bruno Albuquerque, an economist at the International Monetary Fund. “This has detrimental effects on healthy firms who compete in the same sector.”
“A really healthy, well-capitalized banking system and financial sector is one of the most important factors in ensuring that unhealthy firms are wound down in a timely way rather than being propped up,” said Kathryn Judge, a professor of law at Columbia University.
Economists say that zombie firms may become more prevalent when banks or governments bail out unviable firms. But the Federal Reserve says the share of firms that are zombies fell after the Covid-19 emergency stimulus measures were implemented. The Fed says banks are refusing to keep weak firms in business with favorable extensions of credit.
The Fed economists point to healthy balance sheets at U.S. firms, despite the increasing weight of interest rate hikes. The effective federal funds rate was 5.33% in October 2023, up from 0.08% in October 2021.
“The biggest implication of the rapid rise in interest rates that we’ve seen the last five or six quarters, actually, is that it reestablished cash,” said Lotfi Karoui, chief credit strategist at Goldman Sachs. “That actually puts some constraints on risk assets.”
The Fed says it thinks interest rates will remain higher for longer. “Given the fast pace of tightening, there may still be meaningful tightening in the pipeline,” Fed Chair Jerome Powell said at an Economic Club of New York speech Oct. 19.
Watch the video above to learn more about the Fed’s battle with unviable zombie firms in the U.S.
The 10-year Treasury yield continued to pull back from 5% on Friday after moving tantalizingly close to surpassing that level in the previous session.
The yield touched 5% at 5:02 p.m. Eastern time on Thursday, only to drift back down, according to Tradeweb data. It ended Friday’s New York session down by 6.3 basis points at 4.924%.
Rising Middle East tensions gave way to renewed safe-haven demand in government debt on Friday that not only sent the 10-year yield BX:TMUBMUSD10Y
lower, but dragged down rates on everything from 3-month Treasury bills BX:TMUBMUSD03M
to the 30-year bond BX:TMUBMUSD30Y.
Investors were trying to catch the proverbial falling knife by taking advantage of a cheaper 10-year Treasury note, the product of recent selloffs. Analysts warn that it’s difficult to have much short-term conviction in catching that knife, however, given the likelihood that the selloff could return.
One big reason is the onslaught of new supply from the U.S. Treasury as the result of the government’s growing borrowing needs, which is raising the risk that investors will keep demanding more compensation to hold long-dated debt to maturity.
On Oct. 30 and Nov. 1, which is the same day as the Federal Reserve’s next policy decision, Treasury is expected to provide updated guidance on its borrowing needs and auction sizes. Treasury’s refunding announcement could even upstage the Federal Open Market Committee — creating “fertile ground for a continuation of the selloff in Treasuries,” said BMO Capital Markets rates strategists Ian Lyngen and Ben Jeffery.
Over the next several weeks, “it becomes much easier to envision a surge in Treasury yields in anticipation of the upcoming coupon supply,” they wrote in a note on Friday. While the 10-year yield has stopped shy of 5%, “we continue to expect this milestone will be reached shortly.”
Stock-market investors have been focused on the prospects of a 5% 10-year yield because such a level would dent the appeal of equities and make government debt a more attractive investment by comparison.
As of Friday, the 10-year yield, used as the benchmark on everything from mortgages to student and auto loans, has jumped 163.9 basis points from its 52-week low of almost 3.29% reached on April 5. The 10-year yield hasn’t ended the New York session above 5% since July 19, 2007.
COMP
ended the day lower as the prospects of a widening conflict in the Middle East triggered a flight-to-safety trade into Treasurys.
Taking a step back, a 5% 10-year yield would imply that a Goldilocks-scenario of a U.S. economy — one that’s neither too hot or too cold, and able to sustain moderate growth — “is here to stay for a decade,” or that the Fed’s main interest-rate target needs to be materially higher on average over the next decade, according to BMO’s Lyngen and Jeffery. One of the biggest questions facing policy makers is whether the economy might be moving into a new stage in which even higher interest rates down the road could be required to cool demand and activity.
Though BMO Capital Markets is biased toward lower yields into the weekend given the absence of major economic data on Friday, technical indicators “continue to favor higher rates in the near-term,” and “our conviction that 5% will ultimately be traded through has grown.”
U.S. Treasury yields rose on Wednesday with the 10-year hitting a fresh multiyear high as investors digested the latest economic data and considered the outlook for Federal Reserve interest rates.
The 10-year Treasury yield gained nearly 7 basis points to 4.911%, putting it above 4.9% for the first time since 2007. Meanwhile, the 2-year Treasury yield was trading almost 2 basis points up at 5.231%, around levels last seen in 2006.
Also notably, the 5-year Treasury moved as high as 4.937%, its top level since 2007.
Yields and prices move in opposite directions and one basis point equals 0.01%.
Investors considered fresh economic data as uncertainty about the path ahead for Fed monetary policy grew in recent weeks.
Housing starts accelerated in September, but rose as a slower-than-expected rate, according to data released Wednesday. Building permits fell in the month, but lost less than economists anticipated.
Retail sales figures for September, which were published Tuesday, increased by 0.7% for the month. That’s far higher than the 0.3% anticipated by economists surveyed by Dow Jones, and indicates resilience from consumers in light of higher interest rates and other economic pressures.
The data brought up renewed concerns over the outlook for interest rates, with some investors viewing it as an indication that rates may be hiked further or at least kept elevated for longer.
Markets are still pricing in a 90% chance that rates will remain unchanged when the Fed announces its next monetary decision on Nov. 1, but the probability of a December rate increase rose after Tuesday’s data, according to the CME Group’s FedWatch tool.
In recent days and weeks, various Fed officials have indicated that the central bank may be done hiking, especially as higher Treasury yields are contributing to tighter economic conditions. Further comments from policymakers are expected this week, including by Fed Chairman Jerome Powell, and investors are looking to their comments for hints about their policy expectations.
Upcoming economic data may also influence opinion among both investors and Fed officials.
The stock market always overreacts, and this year it seems as if investors believe dividend stocks have become toxic. But a look at yields on quality dividend stocks relative to the market underlines what may be an excellent opportunity for long-term investors to pursue growth with an income stream that builds up over the years.
The current environment, in which you can get a yield of more than 5% yield on your cash at a bank or lock in a yield of 4.57% on a10-year U.S. Treasury note BX:TMUBMUSD10Y
or close to 5% on a 20-year Treasury bond BX:TMUBMUSD20Y
seems to have made some investors forget two things: A stock’s dividend payout can rise over the long term, and so can it is price.
It is never fun to see your portfolio underperform during a broad market swing. And people have a tendency to prefer jumping on a trend hoping to keep riding it, rather than taking advantage of opportunities brought about by price declines. We may be at such a moment for quality dividend stocks, based on their yields relative to that of the benchmark S&P 500 SPX.
Drew Justman of Madison Funds explained during an interview with MarketWatch how he and John Brown, who co-manage the Madison Dividend Income Fund, BHBFX MDMIX and the new Madison Dividend Value ETF DIVL,
use relative dividend yields as part of their screening process for stocks. He said he has never seen such yields, when compared with that of the broad market, during 20 years of work as a securities analyst and portfolio manager.
Dividend stocks are down
Before diving in, we can illustrate the market’s current loathing of dividend stocks by comparing the performance of the Schwab U.S. Equity ETF SCHD,
which tracks the Dow Jones U.S. Dividend 100 Index, with that of the SPDR S&P 500 ETF Trust SPY.
Let’s look at a total return chart (with dividends reinvested) starting at the end of 2021, since the Federal Reserve started its cycle of interest rate increases in March 2022:
FactSet
The Dow Jones U.S. Dividend 100 Index is made up of “high-dividend-yielding stocks in the U.S. with a record of consistently paying dividends, selected for fundamental strength relative to their peers, based on financial ratios,” according to S&P Dow Jones Indices.
The end results for the two ETFs from the end of 2021 through Tuesday are similar. But you can see how the performance pattern has been different, with the dividend stocks holding up well during the stock market’s reaction to the Fed’s move last year, but trailing the market’s recovery as yields on CDs and bonds have become so much more attractive this year. Let’s break down the performance since the end of 2021, this time bringing in the Madison Dividend Income Fund’s Class Y and Class I shares:
Fund
2023 return
2022 return
Return since the end of 2021
SPDR S&P 500 ETF Trust
14.9%
-18.2%
-6.0%
Schwab U.S. Dividend Equity ETF
-3.8%
-3.2%
-6.9%
Madison Dividend Income Fund – Class Y
-4.7%
-5.4%
-9.9%
Madison Dividend Income Fund – Class I
-4.7%
-5.3%
-9.7%
Source: FactSet
Dividend stocks held up well during 2022, as the S&P 500 fell more than 18%. But they have been left behind during this year’s rally.
The Madison Dividend Income Fund was established in 1986. The Class Y shares have annual expenses of 0.91% of assets under management and are rated three stars (out of five) within Morningstar’s “Large Value” fund category. The Class I shares have only been available since 2020. They have a lower expense ratio of 0.81% and are distributed through investment advisers or through platforms such as Schwab, which charges a $50 fee to buy Class I shares.
The opportunity — high relative yields
The Madison Dividend Income Fund holds 40 stocks. Justman explained that when he and Brown select stocks for the fund their investible universe begins with the components of the Russell 1000 Index RUT,
which is made up of the largest 1,000 companies by market capitalization listed on U.S. exchanges. Their first cut narrows the list to about 225 stocks with dividend yields of at least 1.1 times that of the index.
The Madison team calculates a stock’s relative dividend yield by dividing its yield by that of the S&P 500. Let’s do that for the Schwab U.S. Equity ETF SCHD
(because it tracks the Dow Jones U.S. Dividend 100 Index) to illustrate the opportunity that Justman highlighted:
Index or ETF
Dividend yield
5-year Avg. yield
10-year Avg. yield
15-year Avg. yield
Relative yield
5-year Avg. relative yield
10-year Avg. relative yield
15-year Avg. relative yield
Schwab U.S. Dividend Equity ETF
3.99%
3.41%
3.20%
3.16%
2.6
2.1
1.8
1.6
S&P 500
1.55%
1.62%
1.79%
1.92%
Source: FactSet
The Schwab U.S. Equity ETF’s relative yield is 2.6 — that is, its dividend yield is 2.6 times that of the S&P 500, which is much higher than the long-term averages going back 15 years. If we went back 20 years, the average relative yield would be 1.7.
Examples of high-quality stocks with high relative dividend yields
After narrowing down the Russell 1000 to about 225 stocks with relative dividend yields of at least 1.1, Justman and Brown cut further to about 80 companies with a long history of raising dividends and with strong balance sheets, before moving further through a deeper analysis to arrive at a portfolio of about 40 stocks.
When asked about oil companies and others that pay fixed quarterly dividends plus variable dividends, he said, “We try to reach out to the company and get an estimate of special dividends and try to factor that in.” Two examples of companies held by the fund that pay variable dividends are ConocoPhillips COP, -0.29%
and EOG Resources Inc. EOG, +0.52%.
Since the balance-sheet requirement is subjective “almost all fund holdings are investment-grade rated,” Justman said. That refers to credit ratings by Standard & Poor’s, Moody’s Investors Service or Fitch Ratings. He went further, saying about 80% of the fund’s holdings were rated “A-minus or better.” BBB- is the lowest investment-grade rating from S&P. Fidelity breaks down the credit agencies’ ratings hierarchy.
Justman named nine stocks held by the fund as good examples of quality companies with high relative yields to the S&P 500:
Now let’s see how these companies have grown their dividend payouts over the past five years. Leaving the companies in the same order, here are compound annual growth rates (CAGR) for dividends.
Before showing this next set of data, let’s work through one example among the nine stocks:
If you had purchased shares of Home Depot Inc. HD, -0.39%
five years ago, you would have paid $193.70 a share if you went in at the close on Oct. 10, 2018. At that time, the company’s quarterly dividend was $1.03 cents a share, for an annual dividend rate of $4.12, which made for a then-current yield of 2.13%.
If you had held your shares of Home Depot for five years through Tuesday, your quarterly dividend would have increased to $2.09 a share, for a current annual payout of $8.36. The company’s dividend has increased at a compound annual growth rate (CAGR) of 15.2% over the past five years. In comparison, the S&P 500’s weighted dividend rate has increased at a CAGR of 6.24% over the past five years, according to FactSet.
That annual payout rate of $8.36 would make for a current dividend yield of 2.79% for a new investor who went in at Tuesday’s closing price of $299.22. But if you had not reinvested, the dividend yield on your five-year-old shares (based on what you would have paid for them) would be 4.32%. And your share price would have risen 54%. And if you had reinvested your dividends, your total return for the five years would have been 75%, slightly ahead of the 74% return for the S&P 500 SPX during that period.
Home Depot hasn’t been the best dividend grower among the nine stocks named by Justman, but it is a good example of how an investor can build income over the long term, while also enjoying capital appreciation.
Here’s the dividend CAGR comparison for the nine stocks:
This isn’t to say that Justman and Brown have held all of these stocks over the past five years. In fact, Lowe’s Cos. LOW, +0.27%
was added to the portfolio this year, as was United Parcel Service Inc. UPS, -0.16%.
But for most of these companies, dividends have compounded at relatively high rates.
When asked to name an example of a stock the fund had sold, Justman said he and Brown decided to part ways with Verizon Communications Inc. VZ, -0.94%
last year, “as we became concerned about its fundamental competitive position in its industry.”
Summing up the scene for dividend stocks, Justman said, “It seems this year the market is treating dividend stocks as fixed-income instruments. We think that is a short-term issue and that this is a great opportunity.”
The yield on the 30-year Treasury bond briefly rose above 5% again on Friday, opening the door to the likelihood of a more sustainable rise above that mark and the risk that the benchmark 10-year yield follows — moves which could wreak havoc across financial markets.
One big reason is that investors are likely to demand greater compensation for taking risk as yields hover around some of the highest levels of the past 16 years, asset managers said. Corporate credit spreads could keep widening in a sign of worsening economic conditions and higher overall risk. And with returns on government debt becoming a more favorable option for investments, the stock market may be vulnerable to repeated drubbings.
Stock investors nonetheless shook off Friday’s stunning official jobs report for September, which saw the U.S. add almost twice as many jobs as forecasters had expected. All three major stock indexes DJIA
COMP
finished higher even though yields climbed on everything from the 1-month T-bill BX:TMUBMUSD01M
to the 30-year bond BX:TMUBMUSD30Y.
The yield on the long bond finished at 4.941% — the highest level since Sept. 20, 2007 — after rising past 5% during the New York morning. The rate on the 10-year note BX:TMUBMUSD10Y
ended at 4.783%, the second-highest level of this year.
Yields are returning to more normal-looking levels that prevailed before the 2007-2009 recession as the result of aggressive selloffs in government debt. More important than the absolute level of yields is the speed with which they have been heading to 5%. In the words of analyst Ajay Rajadhyaksha of Barclays earlier this week, there’s “no magic level” that will turn the current selloffs into a rally, and stocks have substantial room to reprice lower before bonds stabilize.
“I think the market isn’t breaking yet, but a 5% 10-year yield is coming,” said Robert Daly, who manages $4.5 billion in assets as director of fixed income at Glenmede Investment Management in Philadelphia. “We’re already here on 30s and not that far away on 10s. Investors are trying to figure what level breaks the market, and I don’t think you can put your finger on the pulse as to what that level is.”
Still, “a higher level of interest rates and yields is going to start having ramifications for broader markets at large,” leaving many investors hesitant to buy just about anything due to the volatility, Daly said via phone on Friday, after the release of September’s hot payrolls data.
Friday’s data, which showed the U.S. creating 336,000 new jobs last month or almost double what economists had expected, is opening the door to a possible interest rate hike by the Federal Reserve on Nov. 1. The strong labor market means the Fed’s higher-for-longer mantra in rates is still in play and “the market is in a tenuous position to navigate all these things because of all the uncertainty,” Daly said.
“Yields sustainably above 5% for a longer period of time will act as a weight on the market in terms of how you value risk compensation,” he said. “Investors are going to ask for more compensation to take risk and when you see liquidity evaporate more and more, that’s what’s going to turn the market over.”
Friday’s price action was the second time this week that data related to the robust U.S. labor market has triggered a bonds selloff. On Tuesday, a snapback in U.S. job openings for August sent the 10- and 30-year yields to their highest closing levels since August-September of 2007.
The next day, high-grade corporate-credit spreads widened for a seventh consecutive session. Daniel Krieter, a fixed-income strategist at BMO Capital Markets, wrote that “if rates continue to move higher or simply remain at these elevated levels for a significant period of time, it is going to have a pronounced effect on the creditworthiness of corporate borrowers, particularly in the high yield space.”
In a note on Friday, Krieter’s colleagues, rates strategists Ian Lyngen and Ben Jeffery, wrote that “it’s not difficult to envision 10s maintain a range between 4.75% and 5.00%.”
“The longer 10s hold this range, the more convinced the market will become that elevated yields are here to stay,” Lyngen and Jeffery said. “Admittedly, we’ve been surprised by the muted response in U.S. equities from the spike in yields and expect that’s due in part to the expectation for a swift reversal. In the event a correction fails to materialize, stocks will be overdue for a more meaningful reckoning.”
The risk of “something breaking” will remain top of mind and “there is no shortage of risks facing equities and credit as rates continue to climb,” they added. “It’s not only the outright level of yields, but the length of time that borrowing costs stay elevated will also hold implications for risk asset valuations.”
The 10-year Treasury bond is on track for a third year of losses in 2023, something that hasn’t happened in 250 years of U.S. history.
In short, it has never happened, say strategists at Bank of America.
The return for investors putting money in that bond BX:TMUBMUSD10Y
stands at negative 0.3% so far in 2023, after a 17% slump in 2022 and a 3.9% drop in 2021, the bank’s strategists, led by Michael Hartnett, pointed out in a note on Friday.
Here’s a visual on that:
That reflects a “staggering 40% jump in U.S. nominal GDP growth” — factoring in growth and inflation — “since the COVID lows of 2020,” they said, providing this chart:
Bond returns have suffered this year as the Federal Reserve has continued its interest-rate-hiking campaign aimed at getting inflation under control. The “big picture in the 2020s vs. the 2010s is lower stock and bond returns, which we would expect to continue given political, geopolitical, social [and] economic trends,” said Hartnett and the team.
SPX,
but the bounce since COVID pandemic restrictions began to be lifted has been very concentrated in U.S. stocks, especially the technology sector, with breadth in global markets “breathtakingly bad,” the analysts said. Breadth refers to the number of stocks actively participating in a rally.
Breadth is the worst since 2003 for the MSCI ACWI, which captures large- and midcap-stock representation across 23 developed markets and 24 emerging ones.
As for the latest weekly flows into funds, Bank of America reported that $10.3 billion went to stocks, $6.5 billion to cash and $1.7 billion to bonds, with $300 million draining from gold GC00, -0.06%.
The yield on the 10-year Treasury was holding steady on Friday at 4.102% after data showed the U.S. economy generated 187,000 jobs in August, but the unemployment rate rose to 3.8% from 3.5%, and job gains were revised lower for July and June.
The 10-year Treasury bond is on track for a third year of losses in 2023, something that hasn’t happened in 250 years of U.S. history.
In short, it has never happened, say strategists at Bank of America.
The return for investors putting money in that bond BX:TMUBMUSD10Y
stands at negative 0.3% so far in 2023, after a 17% slump in 2022 and a 3.9% drop in 2021, the bank’s strategists, led by Michael Hartnett, pointed out in a note on Friday.
Here’s a visual on that:
That reflects a “staggering 40% jump in U.S. nominal GDP growth” — factoring in growth and inflation — “since the COVID lows of 2020,” they said, providing this chart:
Bond returns have suffered this year as the Federal Reserve has continued its interest-rate-hiking campaign aimed at getting inflation under control. The “big picture in the 2020s vs. the 2010s is lower stock and bond returns, which we would expect to continue given political, geopolitical, social [and] economic trends,” said Hartnett and the team.
SPX,
but the bounce since COVID pandemic restrictions began to be lifted has been very concentrated in U.S. stocks, especially the technology sector, with breadth in global markets “breathtakingly bad,” the analysts said. Breadth refers to the number of stocks actively participating in a rally.
Breadth is the worst since 2003 for the MSCI ACWI, which captures large- and midcap-stock representation across 23 developed markets and 24 emerging ones.
As for the latest weekly flows into funds, Bank of America reported that $10.3 billion went to stocks, $6.5 billion to cash and $1.7 billion to bonds, with $300 million draining from gold GC00, +0.02%.
The yield on the 10-year Treasury was holding steady on Friday at 4.102% after data showed the U.S. economy generated 187,000 jobs in August, but the unemployment rate rose to 3.8% from 3.5%, and job gains were revised lower for July and June.
While negative returns might stir bad memories of last year’s shocking losses for bonds, stocks and nearly everything else, investors holding Treasury debt issued at 2023’s higher yields might want to sit back and take stock.
“This is the top thing we hear,” said Ryan Murphy, director of fixed-income business development at Capital Group, of evaporating returns in what’s been a tough August. “You saw the worst bond market in 40 years last year. Investors, they are tired, and feel beaten up.”
Murphy’s message to clients is this: “In bonds, you earn the money over time.” And those dwindling bond returns since January? “Approach it with a deep breath, and know this is going to work out in the end.”
Capital Group’s laid-back style and lack of “a star CEO” earned it recognition by Institutional Investor in March as “a new bond leader” without a king, in large part because it attracted $100 billion in funds over the past five years, or twice the total of its peers.
Recent volatility in interest rates again zapped yearly gains in many bond funds, as Fed officials continued to warn that a roaring labor market and robust spending could keep inflation from receding to the central bank’s 2% annual target.
The spike in long-term bond yields makes older, lower-yielding securities look comparatively less attractive. That’s reflected in the yearly return on a key Bloomberg U.S. government bond and note index, which turned negative for the first time since March (see chart), when several regional banks failed, stoking fears of a broader banking crisis.
Returns on U.S. government bonds turn negative for the year.
FactSet
However, a look back at August 2022 shows the 10-year Treasury yield starting around 2.6%, according to FactSet.
By contrast, Treasury bill yields BX:TMUBMUSD06M
neared 5.5% on Thursday, or “north of anything we’ve seen over the past 15 years,” Murphy said. And for investors looking to lock in longer-term yields, the 10-year Treasury rate BX:TMUBMUSD10Y
touched 4.307% on Thursday, its highest level since November 2007, according to Dow Jones Market Data.
“It’s becoming more expensive for the government and companies to finance debt because of the rapid climb in rates,” Murphy said of the drag of higher long-term interest rates.
On the flip side, it’s also been one of the best stretches for lenders and bond investors in terms of getting paid to act as creditors since the 2007-2008 global financial crisis, but without a U.S. recession — or at least not yet.
What’s also different from last year is that the Fed already jacked up interest rates to a 22-year high of 5.25%-5.5% in July, and has signaled it’s likely nearly finished with hikes in this cycle.
Record cash on the sidelines
Murphy pointed to a mountain of cash on the sidelines, in the form of assets in money-market funds, as another potential stabilizer for markets.
Assets in money-market funds hit a record $5.57 trillion for the week ending Wednesday, according to data from the Investment Company Institute.
“What’s really interesting is that there’s been two bursts of investors going into money-market funds. There was a big shift right at the onset of COVID, and another burst over the past 12-18 months since the beginning of the rate-hiking cycle,” Murphy said.
Looking back to 2008, he pointed to a similar buildup in money-market assets, and a roughly $1.1 trillion wall of cash subsequently leaving the sector, as financial assets began to recover in the wake of the financial crisis.
“What we did see, while not all of it, was a healthy amount went back into fixed-income in the following years,” Murphy said.
Stocks closed lower Thursday and were headed for another week of losses, with the Dow Jones Industrial Average DJIA
2.3% lower on the week so far, the S&P 500 index SPX
down 2.1% and the Nasdaq Composite Index off 2.4%, according to FactSet.
A worsening U.S. fiscal situation caught stock and bond investors off guard in the past week and now a round of approaching government auctions is about to provide a crucial test for Treasurys.
The question in the days ahead is whether risks to the demand for U.S. government debt are growing. If so, that could put upward pressure on Treasury yields, which would undermine the performance of stocks. However, if investors end up caring less about the fiscal situation than they do about the possibility of slowing economic growth and decelerating inflation, government debt’s safe-haven appeal could be reinforced, putting a limit on how high yields might go.
Concern about the deteriorating fiscal outlook was a factor behind the past week’s rise in long-term Treasury yields. Ten- BX:TMUBMUSD10Y
and 30-year yields BX:TMUBMUSD30Y
respectively jumped to 4.188% and 4.304% on Thursday, the highest levels since early November, as investors sold off long-term government debt — which took the shine off U.S. stocks. By Friday, though, a moderating pace of U.S. job creation for July sent yields into reverse, giving equities a temporary lift during the final trading session of the week.
At issue is the extent to which potential buyers of Treasurys may be deterred by Fitch Ratings’ Aug. 1 decision to cut the U.S. government’s top AAA rating, at a time when the government is about to unleash what Barclays rates strategists describe as a “tsunami” of supply. A total of $103 billion in 3-, 10-and 30-year Treasurys come up for sale between Tuesday and Thursday. In addition, a spate of Treasury bills are scheduled to be auctioned starting on Monday.
Gene Tannuzzo, global head of fixed income at Boston-based Columbia Threadneedle Investments, said that while he and his team still have room to add T-bills to the government money-market funds they oversee during the week ahead, they haven’t made up their minds about whether to buy more longer-dated maturities for their bond funds.
“While we are comfortable that the Fed is at or near the end of its rate hikes, there are a lot more questions about the durability of the economic recovery, the degree that inflation will remain low, and the risk premium that needs to be put in at the long end,” Tannuzzo said via phone.
Treasury’s $1 trillion third-quarter borrowing plans, along with some technical issues and the Bank of Japan’s decision to switch to a more flexible yield-curve control approach, might reduce demand for U.S. government debt, he said. Columbia Threadneedle managed $617 billion as of June.
“One can’t ignore the risk of an unruly rise in yields, but our view is that this is a low risk and what the Treasury auctions may produce instead is ‘indigestion,’ driven by poor technicals and low liquidity, Fitch’s downgrade, and the Bank of Japan action — and by the end of August, we should be past much of this,” he told MarketWatch.
Risks to the demand for Treasurys may become obvious soon, given Tuesday-Thursday’s $103 billion in total sales of 3-, 10- and 30-year securities, according to analyst John Canavan of U.K.-based Oxford Economics. The main “question mark” for the market’s ability to absorb the increased Treasury issuance will be whether or not domestic investment funds continue to show interest, Canavan wrote in a note distributed on Friday.
Source: Oxford Economics.
“ ‘My suspicion is that with higher rates comes equally solid demand’ at upcoming auctions.”
— John Flahive, head of fixed income at BNY Mellon Wealth Management
Market players have had little difficulty absorbing Treasury coupon issuances in recent years because of flight-to-safety trades made after the U.S. onset of the Covid-19 pandemic in 2020. Now, however, increased auction sizes are being accompanied by still-elevated inflation, better-than-expected economic growth, and the possibility of more rate hikes by the Federal Reserve — which is likely to complicate the market’s ability to absorb the increased supply “without hiccups,” Canavan said.
On the flip side of the debate is John Flahive, head of fixed income at BNY Mellon Wealth Management in Boston, which managed $286 billion in assets as of June. He said equity markets will continue to be much more focused on economic developments and earnings. And as long as the latter of the two remains robust, stocks “can grind higher in a low-volatility environment,” Flahive said via phone.
Saying he does not expect his team to be a major participant in the Treasury auctions, Flahive said that the bond market’s reaction in the past week was “a little overdone” and “we always felt that there was a limited to how much yields could go up to reflect more government debt.”
“My suspicion is that with higher rates comes equally solid demand” at upcoming auctions, he said. “I’m still optimistic about rates going back down over time as the result of a slowing economy and decelerating inflation. We continue to like the bond market and see a better-than-even chance that yields go down as the economy continues to weaken in the quarters ahead.”
Friday’s reaction to July’s official jobs report, which showed the U.S. added a modest 187,000 new jobs, provided a breather from the past week’s run-up in Treasury yields.
On Friday, the 30-year Treasury yield fell 9 basis points to 4.214%, yet still ended with its biggest weekly gain since early February. The 10-year rate, which dropped 12.8 basis points to 4.06%, finished with a third straight week of advances.
Stocks fell Friday, leaving major indexes with weekly declines. The Dow Jones Industrial Average DJIA
posted a 1.1% weekly fall, while the S&P 500 SPX
shed 2.3% and the Nasdaq Composite COMP
retreated 2.9%. The soft start to August comes after a run of sharp gains for equities. The S&P 500 remains up 16.6% for the year to date.
The economic calendar for the week ahead includes U.S. inflation updates.
On Monday, June consumer-credit data is set to be released. Tuesday brings the NFIB’s small business optimism index, plus data on the U.S. trade balance and wholesale inventories. Then on Thursday, weekly initial jobless claims and the July consumer-price index are released. That’s followed on Friday by the producer-price index for last month and an August consumer-sentiment reading.
Meanwhile, portfolio manager and fixed-income analyst John Luke Tyner at Alabama-based Aptus Capital Advisors, which manages roughly $5 billion in assets, said he plans to follow the Treasury auctions, but doesn’t usually participate in them.
“One of the biggest trends we’ve seen is the continued increase in the issuance amounts from Treasury. Whatever we are budgeting for is never enough, which justifies the Fitch downgrade,” Tyner said via phone. “It’s tough to say people aren’t going to buy U.S. debt, but you’ve got to entice them to buy duration and take the risk.
“The U.S. is not an emerging market, but ultimately we are going to see the market rate that participants require be higher, with a notable uptick in term premia,” he said. “What we could see in the face of all this issuance is a grind up in yields on an auction-by-auction basis. If I look at the technicals, a 4.9%-5% yield on the 10-year note seems in the cards,” and “it will be difficult for stocks to hold or expand from full valuations as rates run up.”
The Japanese yen strengthened and 10-year JGB yield rose after the Bank of Japan said it would allow “greater flexibility” in its target range for 10-year Japanese government bond yields.
Yields for 10-year Japanese government bonds stood at 0.551% on the news, the level since September 2014. The yen was trading at 138.64 against the dollar at 12:35p.m. Hong Kong and Singapore time.
After a two day policy meeting, Japan’s central bank adjusted its stance on its yield curve control policy, saying that it will continue to allow 10-year government bond yields to fluctuate in the range of around plus and minus 0.5%.
The BOJ also offered to buy 10-year JGBs at 1% every business day through fixed-rate operations, unless no bids are submitted. The move effectively expands its tolerance by another 50 basis points.
Earlier, currency markets were testing the waters after Nikkei reported the BOJ will let long-term interest rates rise beyond its cap of 0.5% “by a certain degree” at its monetary policy meeting today.
Under its yield curve control policy, the central bank targets short-term interest rates at -0.1% and the 10-year government bond yield at 0.5% above or below zero.
With inflation having exceeded the BOJ’s 2% target, concerns are rising that Japan’s relatively low interest rates have made the yen less attractive and vulnerable to selling.
Central banks around the world have raised rates aggressively to rein in on inflation, but Japan has continued to maintain an ultra-loose monetary policy and kept rates low.
On Friday, the Tokyo’s core consumer price index, which excludes volatile fresh food but includes fuel costs, rose 3.0% in July from a year ago. That’s slightly more than the 2.9% expected in a Reuters consensus poll.
Worries about a possible policy tweak by the Bank of Japan threw a wet blanket on a stretched U.S. stock-market rally Thursday, with the Dow Jones Industrial Average snapping its longest winning streak since 1987 after the 10-year Treasury yield surged back above the 4% level.
The Japanese yen also strengthened after a news report said policy makers on Friday would discuss a possible tweak to the Bank of Japan’s so-called yield-curve control policy that would loosen the cap on long-dated government bond yields.
Nikkei, without citing sources, reported that BOJ officials would talk about the matter at Friday’s policy meeting and that the potential change would allow the yield on the 10-year Japanese government bond TMBMKJP-10Y, 0.440%
to trade above its cap of 0.5% “to some degree.”
‘Ultimate fear’
Why is that a negative for U.S. Treasurys and, in turn, U.S. stocks?
The “ultimate fear” is that Japanese investors, who have vast holdings of U.S. fixed income, including Treasury notes and other securities, “begin to see a higher level of yields in their own backyard,” Torsten Slok, chief economist at Apollo Global Management, told MarketWatch in a phone interview. That could prompt heavy liquidation of those U.S. positions as investors repatriate holdings to reinvest the proceeds at home.
That dynamic explains the knee-jerk reaction that saw the 10-year U.S. Treasury yield TMUBMUSD10Y, 4.004%
surge more than 16 basis points to end above 4%, he said. Yields rise as debt prices fall.
The surge in yields, in turn, saw stocks give up early gains, with U.S. indexes ending lower across the board.
What is yield curve control?
The Bank of Japan began implementing yield curve control, or YCC, in 2016, a policy that aims to keep government bond yields low while ensuring an upward-sloping yield curve. Under YCC, the BOJ buys whatever amount of JGBs is necessary to ensure the 10-year yield remains below 0.5%.
Nikkei said a possible tweak would allow gradual increases in the yield above 0.5%, but would clamp down on any sudden spikes, allowing the BOJ to rein in fluctuations driven by speculators.
Global market participants are sensitive to changes in YCC. The BOJ sent shock waves through markets in December when it lifted the cap from 0.25% to 0.5%. Investors were rattled by the prospect of the Bank of Japan giving up its role as the remaining low-rate anchor among major central banks.
BOJ Gov. Kazuo Ueda in May said the bank would start shrinking its balance sheet and end its yield-curve control policy if a 2% inflation looks achievable and sustainable after many years of undershooting.
Yen rallies
The yield on the 10-year JGB has traded above 0.4%, but remained below the 0.5% cap. Continued interest rate rises by the Federal Reserve and other major central banks in the past year have raised worries that the 10-year JGB yield could test the limit, Nikkei reported. Those rate hikes, meanwhile, have added pressure to the yen, whose weakness is seen contributing to inflation pressures.
The yen USDJPY, -0.02%
strengthened following the report. The U.S. dollar was off 0.5% versus the currency, fetching 139.48 yen.
The Dow Jones Industrial Average DJIA, -0.67%
ended the day down nearly 240 points, or 0.7%, snapping a 13-day winning streak, while the S&P 500 SPX, -0.64%
declined 0.6% and the Nasdaq Composite COMP, -0.55%
lost 0.5%.
Japanese stocks have solidly outpaced strong gains for U.S. equities in 2023, with the Nikkei 225 NIK, +0.68%
up 26% so far this year versus an 18.7% rise for the S&P 500.
Investors are waiting to see what the Bank of Japan actually has to say.
While the Nikkei report helped “exaggerate” a selloff in Treasurys, the market may be inoculated against bigger swings after the BOJ’s December adjustment to the rate band, said Ian Lyngen and Benjamin Jeffery, rates strategists at BMO Capital Markets, in a note.
The analysts said they expect that “the magnitude of the follow through repricing in U.S. rates will be comparatively more contained than would otherwise be expected.”
More recently, the weak yen has raised the cost of hedging long Treasury positions for Japanese investors. So a stronger yen resulting from a shift toward tighter policy would help make hedging costs for owning Treasurys less onerous for Japanese investors as well, Lyngen and Jeffery wrote, “which over the longer term may begin to make Treasurys more attractive to Japanese buyers and add to the list of sources for duration demand.”
That could make U.S. debt more attractive to new Japanese buyers, Slok agreed.
But that’s oveshadowed by the near-term worry, Slok said, that existing Japanese investors will be inclined to sell Treasurys. Flow data will be very much in focus if the Bank of Japan follows through on the apparent trial balloon floated in the Nikkei report.
Investors will be watching, he said, to see “if the train is leaving the station.”
