Has the 10-year U.S. Treasury yield reached its peak for the cycle?
On the latest edition of Market Week in Review, Senior Investment Strategist Paul Eitelman and Consulting Director Sophie Antal Gilbert discussed the recent rise in the 10-year U.S. Treasury yield, first-quarter earnings season results, and the outcomes of recent central bank meetings in Europe and Japan.
Two possible factors behind surge in 10-year U.S. Treasury yield
The 10-year U.S. Treasury yield touched 3% the week of April 23—for the first time since 2014, Eitelman noted. In his viewpoint, this was largely driven by two factors, one of which is the current rally in commodity prices. “The increase in the cost of commodities has started to stoke some fears of inflationary pressures building in the U.S. again—and that’s a headwind for the bond market,” Eitelman said, noting that the price of U.S. West Texas Intermediate crude oil shot up to roughly $68 a barrel on April 26.
The second factor, in Eitelman’s mind, is increased confidence among fixed-income investors that the U.S. Federal Reserve (the Fed) will deliver on its rate hike guidance for the year. “The bond market has re-priced its Fed interest rate outlook to roughly 3.5 increases this year, which is a significant shift,” he explained.
Eitelman noted that while the rise in the 10-year yield to 3% is an important milestone, he and the team of Russell Investments strategists view it as likely being the peak for interest rates going forward. With an eye toward the slope of the U.S. Treasury yield curve, he noted that the 2-year Treasury yield has been increasing as well, which has allowed for the spread between 10-year and 2-year yields to narrow to just 48 basis points. “This is close to the flattest the yield curve has been during this market cycle,” Eitelman said—“and if we continue to see the slope of the curve flatten, it’s not unreasonable to think it could potentially invert in late 2018 or 2019.” If that does happen, he added, it would be an important early warning sign that the current economic expansion could be nearing the end.
Corporate earnings shine, but stock market stays flat
Shifting gears to first-quarter earnings season, Eitelman said that in the U.S., corporate earnings reported the week of April 23 were fairly strong, continuing a trend from the past few weeks. “So far, around 80% of S&P 500® Index companies that have reported have beat earnings expectations—a very strong number,” he said. Yet, despite all this, the stock market finished relatively flat the week of April 23. Why?
“In my opinion, it’s because the industry consensus for the first quarter had already been for strong earnings growth—yet valuations are already so high to begin with,” Eitelman stated. This, he explained, creates a bit of an expectations problem, as it becomes harder to drive the market even higher from its current level.
What’s the future of quantitative easing in the Eurozone?
The European Central Bank (ECB) and the Bank of Japan (BOJ) both held policy meetings the week of April 23. The press conference following the ECB meeting was largely uneventful, Eitelman said, with few surprises. “ECB President Mario Draghi’s comments seemed to indicate that he remains pretty confident in the macro-economic outlook for the eurozone,” he stated. Eitelman added that, broadly speaking, the ECB appears to be gradually moving toward winding down its quantitative easing program—but that at the moment, it doesn’t look like the central bank is seeing enough inflationary pressure to pull the trigger.
The Bank of Japan’s meeting was a bit more interesting, Eitelman said. “There had been a lot of speculation that at some point, the BOJ might need to back away from fixing the 10-year bond yield at 0%—but Governor Haruhiko Kuroda pushed back against that, saying that the country’s yield curve-controlled policies will be in place for the longer term,” he explained. In Eitelman’s mind, this represents a slightly dovish development—and a positive tailwind for Japanese stocks.