Jones Lang LaSalle
Treasury yields' rise could sock economy
Monday, March 13, 2006
BY ELLEN SIMON
Associated Press
U.S. Treasury yields are creeping higher, threatening to undermine one of the key pillars of economic growth in recent years.
Yields are still low by historical standards, but if they continue to rise, watch out. The effect on everything from stocks to housing to car sales could be profound -- and not in a good way.
Yields on 10-year Treasury notes rose last week to as high as 4.80 percent, a level not seen since June 2004, which drew a warning from David Rosenberg, Merrill Lynch's North American economist.
"When rates back up, growth slows ... quickly. Fully three-quarters of the time in the past five years when we endured a bond yield spasm like we have seen since mid-January, GDP (Gross Domestic Product) growth slowed the following quarter, and by an average of one percentage point," Rosenberg wrote in a note to investors.
Stephen Roach, chief economist at Morgan Stanley, added in a recent note that if rates climb, "this is not good news for a liquidity- driven, asset-dependent global economy."
Housing is the most vulnerable sector if long-term rates continue to rise. The housing boom was fueled largely by cheap money and has already been showing signs of weakness: Sales of new single-family homes declined in four of the past seven months, inventories of unsold new homes are at record highs and the average interest for fixed-rate 30-year mortgages rose this week to 6.37 percent, its highest level in 2 1/2 years.
Auto sales also could be at risk if finance rates rise, adding one more burden to debt-laden consumers.
While most of household debt is tied to a fixed interest rate, 25 percent of household debt is tied to a floating interest rate, according to Merrill Lynch, which estimates those obligations exceed $3 trillion. Rising rates could cost households another $100 billion -- the equivalent of a nearly 2 percent pay cut, the investment firm said.
"(T)hat's not a recession- maker, but it's a pinch nonetheless -- it means a little less steak and a lot more bologna, fewer outings to the nightclub and perhaps one less vacation on the cruise line (but maybe more time at the blackjack table)," Rosenberg wrote.
As a result, Merrill is recommending consumer staple stocks, saying consumers will still need to buy products like soap, socks and shirts.
Mustafa Chowdhury, head of U.S. interest rate research at Deutsche Bank, said credit spreads tend to widen as long-term rates increase, making borrowing even more expensive.
If long-term interest rates get high enough, it could hurt the stock market as rich yields on bonds, and even nice interest on certificates of deposit, make them more attractive alternatives for investors. Small-cap companies, which are more dependent on bank loans than larger companies, are especially vulnerable as interest rates rise.
Bill Davison, managing director of Hartford Investment Management, the investment arm of Connecticut-based Hartford Financial Services Group, said his firm expects yields on 10-year Treasuries to rise above 5 percent.
"If that happens, what you would expect to see is a gradual slowdown of the economy," he said.
Just how high 10-year yields increase will depend in part on whether the Federal Reserve continues to push higher the overnight bank loan rate, which now stands at 4.5 percent after 14 quarter- point increases in the past 20 months, he said.
"The question is, can they really engineer a soft landing and not overshoot," Davison said.
Low bond yields also contributed to the decline in pension fund assets.
"The pension system, collectively, has been just slammed on the low yields," said Lou Crandall, chief economist for Wrightson ICAP, a bond market research firm in Jersey City.
While he emphasized that other issues have hurt pension funds, "part of the problem has been underfunding and part of the reason for underfunding is that pension fund managers thought they were in a better position they really were."
"Everyone may know someone whose fortunes have been changed dramatically because of the stock market, but winners and losers because of lower mortgage rates and worse pension fund returns -- those winners and losers are spread much more broadly across society," he said.
Sadly, a steep rise in long-term rates wouldn't fix pension funds' problems.
"They already own lots of bonds with low coupons and those coupons won't automatically reset," Crandall said.
© 2006 The Star Ledger
© 2006 NJ.com All Rights Reserved.
Treasury yields' rise could sock economy
Monday, March 13, 2006
BY ELLEN SIMON
Associated Press
U.S. Treasury yields are creeping higher, threatening to undermine one of the key pillars of economic growth in recent years.
Yields are still low by historical standards, but if they continue to rise, watch out. The effect on everything from stocks to housing to car sales could be profound -- and not in a good way.
Yields on 10-year Treasury notes rose last week to as high as 4.80 percent, a level not seen since June 2004, which drew a warning from David Rosenberg, Merrill Lynch's North American economist.
"When rates back up, growth slows ... quickly. Fully three-quarters of the time in the past five years when we endured a bond yield spasm like we have seen since mid-January, GDP (Gross Domestic Product) growth slowed the following quarter, and by an average of one percentage point," Rosenberg wrote in a note to investors.
Stephen Roach, chief economist at Morgan Stanley, added in a recent note that if rates climb, "this is not good news for a liquidity- driven, asset-dependent global economy."
Housing is the most vulnerable sector if long-term rates continue to rise. The housing boom was fueled largely by cheap money and has already been showing signs of weakness: Sales of new single-family homes declined in four of the past seven months, inventories of unsold new homes are at record highs and the average interest for fixed-rate 30-year mortgages rose this week to 6.37 percent, its highest level in 2 1/2 years.
Auto sales also could be at risk if finance rates rise, adding one more burden to debt-laden consumers.
While most of household debt is tied to a fixed interest rate, 25 percent of household debt is tied to a floating interest rate, according to Merrill Lynch, which estimates those obligations exceed $3 trillion. Rising rates could cost households another $100 billion -- the equivalent of a nearly 2 percent pay cut, the investment firm said.
"(T)hat's not a recession- maker, but it's a pinch nonetheless -- it means a little less steak and a lot more bologna, fewer outings to the nightclub and perhaps one less vacation on the cruise line (but maybe more time at the blackjack table)," Rosenberg wrote.
As a result, Merrill is recommending consumer staple stocks, saying consumers will still need to buy products like soap, socks and shirts.
Mustafa Chowdhury, head of U.S. interest rate research at Deutsche Bank, said credit spreads tend to widen as long-term rates increase, making borrowing even more expensive.
If long-term interest rates get high enough, it could hurt the stock market as rich yields on bonds, and even nice interest on certificates of deposit, make them more attractive alternatives for investors. Small-cap companies, which are more dependent on bank loans than larger companies, are especially vulnerable as interest rates rise.
Bill Davison, managing director of Hartford Investment Management, the investment arm of Connecticut-based Hartford Financial Services Group, said his firm expects yields on 10-year Treasuries to rise above 5 percent.
"If that happens, what you would expect to see is a gradual slowdown of the economy," he said.
Just how high 10-year yields increase will depend in part on whether the Federal Reserve continues to push higher the overnight bank loan rate, which now stands at 4.5 percent after 14 quarter- point increases in the past 20 months, he said.
"The question is, can they really engineer a soft landing and not overshoot," Davison said.
Low bond yields also contributed to the decline in pension fund assets.
"The pension system, collectively, has been just slammed on the low yields," said Lou Crandall, chief economist for Wrightson ICAP, a bond market research firm in Jersey City.
While he emphasized that other issues have hurt pension funds, "part of the problem has been underfunding and part of the reason for underfunding is that pension fund managers thought they were in a better position they really were."
"Everyone may know someone whose fortunes have been changed dramatically because of the stock market, but winners and losers because of lower mortgage rates and worse pension fund returns -- those winners and losers are spread much more broadly across society," he said.
Sadly, a steep rise in long-term rates wouldn't fix pension funds' problems.
"They already own lots of bonds with low coupons and those coupons won't automatically reset," Crandall said.
© 2006 The Star Ledger
© 2006 NJ.com All Rights Reserved.
posted by Jones Lang LaSalle NJ News Blog at 2:21 PM
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