Rising Treasury yields have rattled the stock market. Relief may be on the way.

By Vivien Lou Chen

'We're encouraged by the dip-buying interest' and 'take solace in the stabilizing bid,' BMO Capital Markets strategists say

Buyers returned to the U.S. government-debt market on Thursday following a two-day selloff in the longest-dated maturities that sent yields to one-month highs. It's the type of buying interest that could keep Treasury yields in check from here.The selloff seen in Treasurys on Tuesday and Wednesday drove the 10-year BX:TMUBMUSD10Y and 30-year BX:TMUBMUSD30Y yields to 4.62% and 4.74%, respectively - levels not seen since April 30 - and rattled investors in the stock market. Stock-market bulls had been relying partly on the idea that borrowing costs, and therefore market-based rates, were already at their peaks before this week's rise in yields. On Wednesday, the Dow Jones Industrial Average DJIA ended at its lowest level since May 2 and the S&P 500 SPX closed at a two-week low after the two-day bond-market selloff, which was driven by poorly received government auctions this week and comments from Minneapolis Federal Reserve Bank President Neel Kashkari that appear to keep a Fed rate hike on the table.

Thursday brought a different dynamic to the bond market as bidders materialized overnight on dip-buying momentum, although stocks still fell into the final hour of trading on possible profit-taking and soft quarterly revenue guidance from Salesforce (CRM) the previous day. The 10-year yield dropped 7 basis points to 4.55%. Read: Why stocks are selling off despite easing 10-year Treasury yields?

Also read: Why 10-year Treasury yields should fall into year end, based on 60 years of historyYields move in the opposite direction to prices in the bond market. They fall when demand for government debt goes up, as is typically the case when there's a flight to safety, concerns about the strength of the U.S. economy, or both. Conversely, yields rise when traders are selling off Treasurys, which tends to occur when there's greater economic optimism or worries about higher-for-longer interest rates and inflation.

The 10-year yield is regarded as a benchmark rate on an array of borrowing costs in the U.S. economy. When the yield goes up, government debt begins to look more appealing relative to stocks and concerns increase about the cost of doing business at many operations. The most advantageous way to trade Treasurys is to buy government debt when yields have already presumably reached their peak. BMO Capital Markets strategists Ian Lyngen and Vail Hartman said they took "solace in the stabilizing bid" seen in the Treasury market on Thursday and added that the 10-year note is just one or two weak economic data prints away from rallying back, which would send its corresponding yield to the mid-May lows of between 4.3% and 4.4%.

One reason for BMO's solace is that buyers rejected a 4.625% level on the 10-year yield overnight, with cash trading at 1.5 times the recent norm amid elevated volumes, the strategists wrote in a note on Thursday. The other reason is that the 10-year sector was the most active among the benchmark issues - typically a sign of "an overseas endorsement for the Treasury market as an asset class," Lyngen and Hartman wrote."We're encouraged by the dip-buying interest at a moment when investors are justifiably content to remain on the sidelines awaiting greater clarity on the trajectory of inflation and employment - with the subsequent implications for monetary policy," they wrote.

At broker-dealer LPL Financial, Lawrence Gillum, chief fixed-income strategist in Charlotte, N.C., said "we still think we end the year lower than current levels." In an email to MarketWatch, he wrote: "Our 2024 year-end target for the 10-year is 3.75% to 4.25%, but [we] acknowledge we're likely going to be higher than those levels until later this year."LPL Financial is of the view that the Fed should be able to still deliver two rate cuts this year and to eventually cut the fed-funds rate target down to 3% to 3.5%, from a current level of 5.25% to 5.5% - scenarios that should enable yields to fall. Absent a financial crisis or geopolitical event, "we don't think the 10-year is going to fall much below 3.75%-4.0%," Gillum said. If LPL Financial turns out to be wrong and traders begin to see no Fed rate cuts this year, "we're likely stuck between 4.5% to 4.75%," the strategist said. Getting to a significantly higher level on yields from here would require traders to either start pricing in rate hikes, which LPL Financial doesn't expect, or a rise in term premia to October 2023 levels, which could occur given concerns about the supply of Treasurys, according to Gillum. Term premia refers to the additional premium that investors expect as compensation for the risk that interest rates may change over time.

The 10-year rate has held within a range of 4.3% to 4.7% in recent months, following a broader repricing and consolidation that took place after Fed Chairman Jerome Powell made a dovish pivot in November. At the time, Powell indicated that the central bank might be done hiking interest rates, which opened the door for 2024 rate cuts to be penciled in by other policy makers and traders.

The 10-year yield's broader range has been between 3.75% and 5% since the Fed starting leaving interest rates unchanged after a 25-basis-point rate hike last July. It has traded on everything from deficit spending to supply and the prospect for Fed rate cuts, said Gregory Faranello, head of U.S. rates trading and strategy at AmeriVet Securities in New York.Overall, "demand still exists between credit and U.S. Treasury yield buyers when rates have backed up" - supported by a general view the next move from the Fed will likely be lower, growth and employment is tempering, and the central bank's balance-sheet runoff will start to slow beginning next month, Faranello said. This comes in addition to the Treasury Department's initiation of a buyback program designed to make the bond market more liquid and resilient, which began on Wednesday.

-Vivien Lou Chen

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05-30-24 1531ET

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