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Wednesday, June 06, 2007

What's the Big Deal About Bond Yield?



The major indices took a tumble as the markets were all eyes on the 10 year yield ($TNX) hitting the 5% mark. This is the highest levels since last summer.

As a trader, it is important to know the inter-market relations between bonds, stocks, gold, currencies and commodities. I have always wanted to learn more about them, but never got around to doing so. Noting the market interest in bond yield lately, I (finally) did some reading on it during the last few days as I'm not very familiar with this topic. A few questions came to my head: Why the rise in bond yield? What's the fuss all about? What's the implication for stock market? As I attempt to satisfy myself with these amateurish answers, please feel free to comment on them.

Why the rise in bond yield?
The ISM Services Index reading on Tue was the highest since April 2006. Together with the recent positive economic data, this signals a strong economy and erased any hope of Fed easing rates anytime soon. So traders anticipating this bid up the bond yield as rising yields contain economic growth and inflation.

What's the fuss all about?
It boils down to the chart (see above). 10 year yield has just broken the late Jan high and now heading towards a psychological 5% mark

What's the implication for stock market?
Theoretically speaking, the bonds market has an inverse relationship with the stock market. Because higher yield would be more attractive to investors and assuming they have fixed dollar amount for investment, they will switch some of their funds from stock market to bonds market. But theory is just theory. So far, the rising yield went hand in hand with the rising stock market. Until yesterday that is. The stock market took a bearish turn amid the 10 year yield threatening 5% level. I think it will make another attempt today to cross 5% if the Nonfarm productivity report is aligned with the ISM index reading. But it will be interesting to see if the stock market will continue to move in the opposite direction of bond yield.


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