The U.S. Treasury market's rally is nearing an end, and the looming selloff could drag the stock market down with it, strategists warn.
Strong demand for Treasurys in recent weeks has pushed benchmark 10-year yield below 1.20% after the breakout to 1.8% from March 2015. The decline came amid a drop in U.S. Treasury issuance that left investors struggling over limited supply.
In recent note on Clients, Deutsche Bank strategist Jim Reid overpowered everything in the US government bond technicals.
There are signs these will ease over the next few weeks, he added. If the yields are still ultra low by September, there will be real evidence of something more structural keeping yields as low as they are.
Citigroup strategists, led by Robert Buckland, say the absence of widening in Credit Spreads indicates all is well in the global economy.
A coming rebound in issuance, ongoing economic recovery and likely tapering of the Fed's asset purchase program will push the 10 - year bond yields back towards 2%, the strategists wrote. Federal Reserve Chairman Jerome Powell said last month that the central bank was still way from tapering asset purchases and hiking interest rates.
The impact of increasing yields on the stock market depends on what happens to real yields, or those adjusted for inflation, according to Citigroup strategists.
They forecast the 80 basis-point decrease in the 10 year yield from 1.2% to 2%, which will be accompanied by a 70 basis-point increase in real yields.
That increase in real yields could prove challenging due to the close relationship between real yields and stock market performance, wrote the strategists.
Growth stocks seem particularly sensitive to real yields, wrote the strategists, who lowered their outlook for U.S. equities to neutral. The growth stocks have been instrumental in the rally of the S&P 500 ( BSE ) through March 2020, the year that it started with the lowest lows.
Goldman Sachs strategists now believe the 10-year yield will climb modestly to 1.6% by year end. Their previous forecast was for the 10 year period to reach 1.9%.
Seeing the passage of the tax reform, they believe that the S&P 500 will rally 7% to 4,700 by the end of this year with high-margin growth stocks being the winners.
However, they warn a scenario where interest rates are higher than expected due to an improving economy, persistent inflation and Fed tightening give the S&P 500 an implied value of 4,350, or 1% below current levels.