NEW YORK - US stock and bond markets have risen in tandem all year as investors in each found reasons to support their views: stocks are up on signs the economy is improving, and bonds have gained on expectations for low inflation and relatively slow growth.
The benchmark Standard & Poor's 500 set multiple records in the last few weeks, while the Barclays US Aggregate Bond Index .BCUSA is up 3.3 per cent this year, having also hit a record. However, the rally in yields that brought the benchmark 10-year bond to its lowest level in nearly a year last week has some investors saying it may be the bond market that's gone too far.
"It's a bit head-scratching," said Bob Doll, chief equity strategist at Nuveen Asset Management with $120 billion in assets under management. "To me there are signs everywhere the economy is about to get better, and we won't know it until we get second-quarter GDP. Inflation is not going to be high but unlikely to be as low at the end of the year as it was at the start of the year.
"When these other things fade away, my view is we could get a quick move up in rates."
Signs that investors are starting to cotton to this are emerging. Stronger-than-expected US economic data, including on recent inflation, has stemmed some of the enthusiasm for Treasuries. The 10-year yield hit 2.60 per cent on Wednesday, highest since mid-May.
And some strategists say the bond market has been unnaturally bolstered by sinking yields in key bond markets in Europe, where the central bank is still ramping up monetary stimulus, as well as by buyers such as pension funds seeking to lock in 2013's equity gains. In Asia, Chinese growth is slowing, while Japan is easing its monetary policy.
CUTTING OFF THE RALLY
Since the 2007-2009 recession, the Federal Reserve has effectively printed about $3 trillion. It has kept interest rates near zero for more than five years, and new Fed chair Janet Yellen said the US central bank will keep them there for a considerable time even after it ends its bond-buying programme.
"We are in a period of low economic growth with little inflation and that's good for fixed income markets," said Gary Pollack, head of fixed income trading at Deutsche Bank Private Banking in New York. "It's also good for equities because they don't have to worry about the Fed raising rates any time soon."
However, the Fed is reducing monthly bond buying, and the April-May bond-market rally that saw the 10-year drop nearly 0.40 percentage point raised concern that the Fed's reduced support would hurt economic growth.
Other outside forces are at least partially responsible for the bond market's rally, investors said.
The European Central Bank is on the verge of introducing more stimulus that has driven down yields on Europe. Investors seeing 10-year rates below 3 per cent in economies such as Spain and Italy have instead shifted to the US
"What bonds are telling us is that the typical US cyclical framework for analysing rates is no longer valid," said Krishna Memani, chief investment officer at OppenheimerFunds in New York, which has about $245 billion under management. "Outside forces should continue to depress US rates even as the US economy and corporate earnings growth gather momentum."