Will The 10-Year Treasury Yield 2% Highter Than Inflation, Its Historical Norm?

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By: Kent Engelke | Capitol Securities

Markets advanced again yesterday as companies indicate the tax overhaul will boost earnings. Treasuries fell for the same reason, a decline amplified by the belief a government shutdown will not occur.

I reiterate I am macro economically bullish, but equity average bearish. I also think the sovereign debt market has entered into a prolonged bear market where yields will perhaps rise back towards the 80-year mean of 4.7% for the 10-year Treasury.

Incidentally, historically the 10-year yields about 2% more than the inflation rate. If this correlation is still relevant, the 10-year today should yield around 4.25% to 4.5%, considerably greater than today’s 2.58% yield.

What are the odds demand pulls inflation, or inflation caused by strong demand, morphs into cost push or wage inflation? Will the 2.5% FOMC mandated inflation rate be shattered?

I think the risks favor for an upside surprise in economic data, thus suggesting possible weakness for a market that is 70% above its historical valuation based upon the PE of the S & P 500. According to the WSJ, the S & P 500 is higher than any time in the 100 years before 1998.

Like most, I do believe earnings will rise, but not enough to offset the rise in input costs and interest rates, hence valuations of the averages may become challenged. However, I also believe Main Street America will outperform Wall Street as funds gravitate back to the real economy.

What will happen today?

Last night the foreign markets were mixed. London was down 0.37%, Paris was up 0.05% and Frankfurt was up 0.39%. China was up 0.13%, Japan was down 0.44% and Hang Sang was up 0.43%.

The Dow should open flat. Oil inventories fell again last night, the largest withdrawal from the biggest US storage complex according to the American Petroleum Institute. The 10-year is off 4/32 to yield 2.60%.

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