Daily State of the Market: Are Rising Bond Yields Good or Bad?

by: David Moenning

Good morning. It is safe to say that one of the primary drivers of the action in the stock market so far this week has been the bond market. For the second day in a row, stocks opened higher on Wednesday only to be driven lower by an impressive surge in bond yields. In the last two days alone, the yield on the 10-year T-Note has gone from 2.94% to 3.24%. And for those of you keeping score at home, since November 4th, the 10-year's yield has soared 75 basis points (0.75%). All during a time when the Fed's objective has been to artificially drive yields down.

The question, of course, is why are yields romping higher all of a sudden? One team suggests that it is the consistently improving data from both here at home and around the world that is causing yields to rise. (Heck, even Japan's GDP was revised higher last night!) And with the economy looking like it is on the mend, inflation can't be far behind, right? So, naturally rates are going to pick up a bit.

Thus, according to the the glass-is-half-full crowd, it is the view that brighter days are ahead that is behind the higher rates. And since an improving economy also brings higher earnings, we shouldn't be too concerned about the bond market at the present time.

On the other side of the field, the more cynical team has a completely different view of this issue. Our furry friends opine that it is the bond vigilantes coming home to roost that are the source of the problem.

In other words, the bond market is saying something along the lines of, "Enough, is enough already with the deficit spending." While yields in the bond market were clearly on the rise prior to this week, the rate of ascent was rather mellow and perhaps even technical in nature. However, once bond traders got wind of the fact that White House had found another way to spend money, well, it was "Katie, bar the door!"

There are really two issues at stake here on the topic of fiscal policy. First, there is the Fed's QE2. All told, the FOMC is purportedly going to buy up about $900 billion in government bonds over the next few months in order to try and keep the economy moving along. While this is disturbing to those who regularly check in on the debt clock, Ben Bernanke has assured us that the Fed is not - repeat not - printing money to buy bonds.

Whether or not you agree with Gentle Ben is up for discussion. However, the fact that the White House has agreed to what amounts to another stimulus bill and that the good 'ol USofA just might have to print money to fund it, is not. And the bottom line is that this is what has the bear camp all riled up.

So, with the U.S. Treasury busy raising money in the bond market this week, the bond vigilantes have apparently decided to make a point. While the nation's economy and politics are quite complicated, the statement being made by the bond vigilantes is simple. In essence, the bond market is telling the government, "If you want to keep printing up money in order to fund everything you can dream up, that's fine ... but it's gonna cost you."

So, which team has it right? Is the bond market discounting brighter days ahead for the economy or are bond traders going to ruin the show? Stick around, because this ought to be interesting.

Turning to this morning ... so far at least, rising bond yields, a downgrade in Ireland (but only of its currency issuer rating), weak data out of the UK, and rising unemployment in the Eurozone haven't affected the mood on Wall Street. But the early action will likely be dictated by the results of the Weekly Jobless Claims report, so let's get to it.

On the economic front ... the Labor Department reported that initial claims for unemployment insurance for the week ending December 4 fell by 17,000 to 421K. The week’s total was 4K below the Reuters consensus for a reading of 425K. Continuing Claims for unemployment for the week ending November 27 were below consensus at 4.086M vs. expectations for 4.247M and last week’s revised (higher) 4.277M.

Stock futures have improved a bit on the news ...

Finally, remember that it pays to be open minded (in more ways than one) ...

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell ...

  • Major Foreign Markets:
    • Australia: +0.75%
    • Shanghai: -1.32%
    • Hong Kong: +0.34%
    • Japan: +0.52%
    • France: +0.58%
    • Germany: -0.05%
    • London: +0.30%
  • Crude Oil Futures: + $0.42 to $88.70
  • Gold: + $1.40 to $1384.60
  • Dollar: higher against the Yen, Euro and Pound
  • 10-Year Bond Yield: Currently trading at 3.236
  • Stocks Futures Ahead of Open in U.S. (relative to fair value):
    • S&P 500: +7.12
    • Dow Jones Industrial Average: +42
    • NASDAQ Composite: +8.50

Wall Street Research Summary

Upgrades:

  • Illumina (ILMN) - Target increased at AURIGA
  • Cooper Tire (CTB) - BofA/Merrill
  • Goodyear Tire (GT) - BofA/Merrill
  • Janus Capital (JNS) - Barclays
  • Legg Mason (LM) - Barclays
  • Waddell & Reed (WDR) - Barclays
  • Fluor (FLR) - Target increased at Credit Suisse
  • WMS Industries (WMS) - Target increased at Credit Suisse
  • Corning (GLW) - Added to Short-Term Buy at Deutsche Bank
  • Intel (INTC) - Added to Short-Term Buy at Deutsche Bank
  • Home Depot (HD) - FBR Capital
  • Sempra Energy (SRE) - Goldman Sachs
  • GeoEye (GEOY) - Estimates increased at JPMorgan
  • Stillwater Mining (SWC) - RBC Capital
  • NTELOS Holding (NTLS) - RBC Capital
  • Triumph Group (TGI) - UBS
  • Walgreens (WAG) - UBS

Downgrades:

  • Lowe's (LOW) - FBR Capital
  • Edison (EIX) - Goldman Sachs
  • Yongye International (YONG) - Oppenheimer
  • Under Armour (UA) - Sterne, Agee
  • Con-way (CNW) - Stifel Nicolaus
  • Paychex (PAYX) - Wells Fargo
  • Johnson & Johnson (JNJ) - Wells Fargo

Disclosure: No long positions in stocks mentioned