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Why 4 percent is the new 3 percent on the 10-year Treasury yield

The 10-year Treasury yield touched 3 percent this week — but the stock markets seemed to pay more attention to corporate earnings. (Justin Lane/Epa-Efe/Rex/Shutterstock)

The long-dreaded 3 percent yield on the 10-year U.S. Treasury bond came and went this week without much hullabaloo.

The Dow Jones industrial average tanked 424 points on a broad sell-off Tuesday, but not all of the blame fell on the 10-year yield touching 3 percent. Most of the finger-pointing was aimed at Caterpillar, the Illinois-based heavy-duty equipment manufacturer that reported robust earnings for the first quarter.

That’s right. Seemed like good news.

Then, Caterpillar’s chief financial officer said in a brief comment deep into an analysts’ call that the first-quarter profit “will be the high-water mark for the year.”


Shares in Caterpillar, a company known for controlled enthusiasm, started tumbling even before the call was over.

As Caterpillar goes, so goes the global economy. The world’s largest maker of earth-moving equipment is closely watched as a harbinger of economic health. Its products service a wide swath of industries, including road construction, petroleum, mining, logging and agriculture.

Investors seemed to take the comment as a sign that the good times are losing steam.

Scott Clemons, chief investment strategist at Brown Brothers Harriman, called the sell-off “a ripple effect” that spread through the industrial sector and then through the Dow 30 and most of the rest of the stock market.

“The comment . . . spooked industrials, as well as the overall market,” Clemons said at the time.

The rest of the story is worth noting: Caterpillar anticipates spending a good deal of its profit for the rest of the year on investments in its business. But in the heat of a trading day and a (nearly) priced-to-perfection market, that sort of context can get lost.

Welcome to 2018, which is quickly becoming “The Year of Volatility.”

Which brings us back to the yield on the 10-year Treasury bond. The 10-year is not exactly the subject of repartee at my dinner table.

Yield is the current income return you receive when, for instance, you own a bond, as measured by a percentage. If the bond you bought for $1,000 pays you $20 per year — that’s a 2 percent annual yield.

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The yield on the 10-year Treasury is closely watched in the financial world because many view it as a window on where the economy is headed: up, down or sideways. Mortgages, corporate debt and a lot of other interest rates are tied closely to the government bond. Those metrics can carry a long tail through the economy.

Not to overstate things, but the current concern is that if the yield on the 10-year bond breaches 3 percent, then inflation is gaining steam, global economic growth could slow, mortgage rates are going to rise, and investors will move money from equities into bonds.

In other words, the thinking goes, maybe the nine-year bull market is kaput. Done. Over. Stick a fork in it.

So what happened to stock markets after the yield on the 10-year bond hit 3 percent this week? Not much. We are all still here, and the Dow held up just fine, thank you. The Dow closed in positive territory on Wednesday, the day after the anticipated Armageddon, propelled by a bullish Boeing — the hot hand in the Dow for the past year.

Markets zoomed 238 points — 1 percent on the nose — Thursday on Facebook’s powerful earnings report . Facebook reported a 63 percent rise in profit a mere two weeks after chief executive Mark Zuckerberg was grilled by Congress. Many thought the social-media giant was toast because of the controversy that engulfed the company after its users’ data was compromised.

The 3 percent yield’s sacred status comes from the belief that it is the point at which investors will flee the relative risky stock market for the relative safety of bonds. A 3 percent yield on bonds is considered a decent return, compared with the yield on the Standard & Poor’s 500-stock index, even though stocks have much more upside because of their earnings potential.

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“Investors and Wall Street like big, round numbers, so they like 3 percent,” said Daniel P. Wiener, chairman of Adviser Investments, based in Newton, Mass.

Wiener said the yield on the 10-year Treasury would need to move above 4 percent to become serious competition against stocks, because S&P 500 companies are boosting their profits left and right.

Stock prices are driven by earnings. Based on that metric, Wiener said that as of today, the S&P earnings yield (not dividend yield) is 4.1 percent.

“My point is that the earnings yield on stocks was higher than the 10-year Treasury bond,” he said. “And by the time the 10-year gets to 4 percent, in theory, we would see higher earnings on the S&P.”

Is the 4 percent yield the new 3 percent? “Yes,” he said. “Bond investors should be looking for a 4 percent yield before they give up on the stock market.”

Howard Silverblatt, a senior index analyst with S&P Dow Jones Indices, said the significance surrounding the 3 percent threshold is overblown.

“The yield on the 10-year, even at 3 percent, is historically low and is still a bargain,” he said. “However, it is the start of an upturn. It’s the final acceptance and proof that low, easy, cheap money is gone.”

But most stuff is going to cost more. Some already does. The price of gasoline at the pump is going up. Mortgage rates are going up. The good news is that wages are, too. As are the interest rates banks are offering you to stash your savings with them.

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“There is competition for your money,” Silverblatt said. The interest rate is well over 2 percent on an 18-month certificate of deposit.

“None of this is Ronald Reagan-era super-savings, where you get a toaster and a 7.75 percent CD that yields 8.17 over five years,” he said.

At 64, Silverblatt remembers well the Great Inflation of the 1970s and the sky-high interest rates that then-Federal Reserve Chairman Paul Volcker (1979-1987) imposed to stamp it out.

“I remember my cousin buying a house at a 16 percent mortgage rate in 1981 and opening a bottle of champagne to celebrate,” Silverblatt said. “The yield on the 10-year was over 15 percent. She was happy as heck.”

Most money wags said you have to have the long view.

Chris Brightman, chief investment officer of Research Affiliates, an institutional investor with more than $200 billion under management, said the historical long-term average yield on the 10-year Treasury bond through bull markets and through recessions is 5 percent.

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Long-term changes in the U.S. labor force, its productivity growth and inflation, would lower the expected 10-year yield to 3.5 percent in the coming decades.

He said markets are paying too much attention to the yield, but he chalks that up to a fixation on a milestone.

“Remember when everybody was scared to death of Y2K,” he said, referring to the angst over what would happen to computers when 1999 gave way to the year 2000. “Y2K happened, and no elevators fell. Planes didn’t drop out of the sky. Events that are widely forecast and everybody knows are coming don’t cause markets to react.”

“With the Federal Reserve having told us over and over for years that the trajectory of the Fed funds rate would move to normal rates, everybody knew the 3 percent yield was coming. We should expect it to go up another half-percent. Three to 4 percent for 10-year Treasury notes is what we should expect.”

The increase in the interest rates is a good sign overall.

“The reason interest rates are going up is because the economy is so healthy,” Brightman said. “The economic dog is wagging the interest-rate tail.”