Bond yields spark credit concerns

Bond yields spark credit concerns
By Michael Mackenzie and Richard Beales in New York and Joanna,Chung in London
Copyright The Financial Times Limited 2007
Published: June 8 2007 03:00 | Last updated: June 8 2007 03:00



The benign credit conditions that have helped fuel the global buyout boom came under threat yesterday as the yield on 10-year US government bonds registered its biggest daily jump in years.

Some analysts suggested the dramatic rise in yields could herald a sustained period of higher interest rates, increasing the cost of borrowing for companies, deflating borrower-friendly credit markets and eventually crimping the outlook for equity markets.

The S&P 500 index fell 1 per cent by midday in New York while the German Dax dropped 1.4 per cent.

"Stocks need to reflect what bond yields are saying," said Michael Kastner, portfolio manager at SterlingStamos. "Rate cuts have been taken away and, if yields start to reflect that rate hikes are likely this year, then it will get pretty ugly for stocks."

The yield on the 10-year US government note hit 5.14 per cent in New York trading, marking the biggest one-day advance in several years, before settling back to 5.10 per cent. That brought 10-year yields above those on shorter-term Treasuries, restoring a more normal - that is, "steeper" - yield curve.

For much of the past year and a half, longer-dated notes have offered lower yields than shorter-duration bills, creating a "conundrum", as Alan Greenspan, then chairman of the Federal Reserve, put it in 2005.

But yields on US, European and Japanese government bonds have been climbing for a month, fuelled by strong economic data and, in places, fear of inflation.

Government bond yields soared yesterday in the eurozone and the UK, pushing the 10-year Bund yield to a four-and-half-year high and the 10-year gilt yield to its highest for nine years.

The moves come a day after the European Central Bank raised its main interest rate to4 per cent. Many investors fear the ECB will continue raising rates this year to counter inflationary pressures. The Bank of England yesterday kept its main interest rate on hold at5.5 per cent, amid investor worries that rates could rise next month or in August. Predictions of a Fed rate cut have largely been abandoned.

The sharp rise in the US 10-year bond yield was particularly disturbing to technical analysts who monitor the pattern of Treasury interest rates, which have been broadly on the decline since the late 1980s. Over this period, each peak in rates has been progressively lower. Yesterday's advance created a higher peak, breaking the trend and potentially signalling a longer-term advance in rates.

"A lot of people are scared of that 20-year trend line and rightfully so," said Gerald Lucas, senior investment adviser at Deutsche Bank. "A close above that level at the end of this week would likely target a further rise to 5.25 per cent."

The 10-year Treasury is widely used to hedge risk associated with fixed income securities.