(Bloomberg) -- It's going to take more than just a few days of extreme turbulence in equities to keep Treasury yields down.
The day after stock-market volatility surged the most on record and the Dow Jones Industrial Average suffered its steepest point drop in history, the 10-year yield resumed its march higher. It was up 6 basis points to 2.77 percent as of about 1 p.m. in New York. While that's down from the four-year high of 2.88 percent reached Monday, it's still above the first-quarter forecasts from 59 of 63 analysts surveyed by Bloomberg.
It wasn't like this in past episodes of equity-market selloffs. In the opening weeks of 2016, for example, 10-year yields dropped more than 70 basis points as equities tumbled on concerns about global economic growth. It's the opposite this time around.
“Fundamentally, everything people are worried about is because of strength in the economy, so good news becomes bad news,” said Bryce Doty, senior portfolio manager at Sit Investment Associates, which oversees $14 billion. “We're going to have more days like this. That's healthy.”
Doty said his firm used Monday's move to sell Treasuries. The pullback in stocks “is not enough to derail an economic freight train.”
Battle Afoot
For Scott Minerd at Guggenheim Partners, the current environment creates a “tug of war” between stocks and bonds. Things are going well in economies around the world, which supports corporate profits and pushes up developed-market yields. It's Treasuries that are supposed to be in a bear market, after all.
Yet when interest rates surge, that raises the specter of a slowdown in spending and borrowing and spooks stocks -- the very dynamic that sparked the price swings in the past few sessions.
So far, equities appear to have found some stability, with the S&P 500 still only down about 1 percent this year. Even Treasury Secretary Steven Mnuchin said Tuesday that the decline in stocks was a “normal market correction,” with economic fundamentals still strong.
Traders seem to agree: They're still pricing in about 2.5 Fed hikes this year, little changed from the 2.8 they expected late last week, based on overnight index swaps and the current effective rate. For most of this tightening cycle, they'd been reluctant to look much past the central bank's upcoming meeting.
Favoring Europe
The expectations that the Fed will stay the course is helping widen the spread on 10-year Treasuries over similar-maturity bunds. Investors are favoring bonds in Europe in a wager that the European Central Bank will be slower in removing monetary accommodation than the Fed.
Wagers on four Fed hikes re-emerged Tuesday in eurodollar futures, with traders buying hawkish put positions. That scenario would be more aggressive than the median projection among policy makers.
Short-term Treasury yields will almost certainly increase if the Fed sticks to its forecast for three hikes. At that point, long-end yield could follow suit, or the curve could flatten toward inversion, a traditional signal of an eventual recession.
And that, in turn, would put all eyes back on stocks.
The tug of war “is just getting underway,” Guggenheim's Minerd said in a Twitter post. “This may be the big investment story for 2018.”
--With assistance from Elizabeth Stanton and Edward Bolingbroke
To contact the reporter on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net.
To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Mark Tannenbaum, Vivien Lou Chen
©2018 Bloomberg L.P.
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