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Why ASX investors shouldn’t fear the spike in the 10-year Treasury yield

Shares are under pressure as the jump in the 10-year Treasury yield on Friday was blamed for a sell-off in the US share market, which experienced its worst weekly loss in a month.

Our S&P/ASX 200 (Index:^AXJO) (ASX: XJO) index is expected to fall into the red this morning in sympathy as the 10-year Treasury (government bond) jumped to a fresh seven-year high of 3.23%.

Few would argue that higher yields are generally a negative for equities, but you won’t find consensus on what the tipping point is.

Some experts believe the Treasury yield will endanger the record bull run when it hits around 3.6%, while others like Geoff Wilson from Wilson Asset Management suggested to the Australian Financial Review that the critical level is around 5%.

I’ve no doubt that the bears will be controlling the market at some point, but I don’t think we will need to worry about this for the next 12-months or so even as we hear an increasing number of experts ring the bell for last drinks on the bull market.

That’s good news for our best performing blue-chip stocks like Santos Ltd (ASX: STO), RESMED/IDR UNRESTR (ASX: RMD), CSL Limited (ASX: CSL) and Computershare Limited (ASX: CPU).

The rise in the 10-year yield is not all negative. The fact is, the yield at the long-end of the curve (bonds with longer maturities like the 10-year) are rising faster than the short-end.

This is positive as the yield curve is steepening (where yields are higher for longer-dated bonds than shorter).

Around a month ago, the yield difference between the 2-year and 10-year yields was around 20 basis points. It’s now 35 basis points.

Several weeks ago, a number of bearish experts were warning of the danger from the flattening of the yield curve as an inverted yield (where the yield on long-dated bonds drop below the short-dated bonds) has been a reliable indicator of an impending recession.

Conversely, a steepening of the yield curve often coincides with strong economic growth although that usually puts pressure on central banks to lift interest rates to cool growth. A rate increase by central banks, like the US Federal Reserve, have a much bigger impact on lifting the yield on shorter-dated bond yields (e.g. one and two-year).

The chatter around the Fed lifting rates too fast and linking it to the spike in the 10-year Treasury yield is a bit of a furphy. The jump in the yield is driven more by stronger than expected economic growth than how hard the Fed will step on the brakes by lifting rates, in my view.

We don’t seem to be anywhere near a recession (barring a Black Swan event) and that should give investors some confidence that our market isn’t heading for a crash.

While we can experience a bear market without an economic recession, it’s fairly unusual. I think any real signs that our bull market is facing an infection point will only come sometime in mid to late 2019, if not later.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Computershare and ResMed Inc. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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