Stock Market Rally Causing Surge In Treasury Yields

by: Daryl Montgomery

While the big Tuesday rally in stocks got all the media attention, the big sell-off in U.S. Treasuries that accompanied it went largely unnoticed. Good news for banks apparently means much higher interest rates and bad news for consumers.

Yields on U.S. treasuries were not that far above historical lows before the boondoggle accompanying the Federal Reserve's stress test announcements. When JPMorgan (NYSE:JPM) jumped the gun and other banks followed on March 13th, stocks mounted a spectacular rally in the last hour of trade. No one asked however where the money to fund all of that stock buying was coming from. Even a casual analysis shows that it came from the selling of U.S. Treasuries (which continued into the next day).

The two-day rise in yields from the bond sell-off was sizable to say the least, with the longer-end of the curve having the biggest gains in absolute terms. Yields were up 26 basis points on the 30-year, 25 basis points on the 10-year, and 26 basis points on the seven-year (a basis point is one hundredth of a percent). Even the five-year yield rose 21 basis points. Essentially, interest rates rose a quarter of a percent on treasuries with maturities of five years or more - and it all happened literally overnight.

Since interest rates were at such low levels, the spike in yields represented a big increase on a percentage basis. This was most pronounced at the middle part of the curve. Yields on the seven-year went from 1.43% to 1.69%, for a gain of 18%. Yields of the five-year went from 0.92% to 1.13%, and this represented a 23% increase. An even bigger jump took place in the three-year with yields, up 28% when rates rose from 0.47% to 0.60%. The two-year though was up only 18% after going from 0.33% to 0.40%. The percentage increase in the 10-year, where yields went from 2.04% to 2.29%, and the 30-year, where yields went from 3.17% to 3.43%, were modest in comparison.

Treasury bills were less affected with yields on the three-month and six-month unchanged. The one-year rate rose from 0.18% to 0.21%. The one-month yield (which went negative in late 2008 and late 2009) went from 0.05% to 0.08%. Yield information for treasuries can be found here.

The Fed's Operation Twist, a plan to sell $400 billion of shorter-dated Treasuries and buy an equivalent amount of longer-dated paper, is still ongoing. By the end of March, a switch of $268 billion will have taken place. The purpose of this operation is to keep rates for the 10-year yield low in order to stimulate the economy. Apparently, it wasn't working so well this week. The Fed publishes the schedule for its Operation Twist sales and purchases and these can be found here.

The rise in interest rates is not just important to investors, but to consumers as well. Consumer loans are frequently based on some formula using the 10-year treasury yield. If this goes up a quarter of a percent, so will the rates on consumer debt. This will be a drag on the economy. While rates have been kept artificially low by the central bank for the last three years (they have gone down during the "recovery," when they should have been going up), the sudden rise in yields this week indicates the Fed may be losing its ability to hold them down.

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.