JP Morgan Chase is forecasting a 13pc fall in Amer-ica's S&P 500 stock index

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US counts cost of Treasury yields
By Ambrose Evans-Pritchard (Filed: 14/04/2006)


Yields on 10-year US Treasuries have risen above 5pc for the first time since 2002 on heavy selling by big institutions, sending tremors through the US mortgage and corporate credit markets.

The US 10-year bond is the key instrument used to price borrowing in the American economy, with ripple effects through the global system.

Yields have risen sharply by 0.6 percentage points so far this year, reaching 5.036pc in New York last night.

The powerful upward draft has lifted German, French and other eurozone bonds in step, driving up the cost of borrowing on the capital markets.

Analysts said the spike in yields is chiefly caused by an exodus of Asian investors, who hold a huge chunk of the US national debt.

"We've started seeing a lot of money being repatriated into the Japanese equities market," said Matthew Smith, a manager at Smith Affiliated Capital. J-apanese holdings of foreign bonds has fallen by $70bn so far this year, according to data from Japan's fin-ance ministry.

Strong US retail sales in March and growing fears that high energy and commodity costs will soon start feeding into core inflation has also weighed on the bond markets.

Michael Taylor, senior economist at Lombard Street Research, said this year's sudden rise in 10-year yields risked tipping the US economy into a downturn.

"This could be the catalyst for a sharp correction in property prices and wean consumers off their credit binge," he said.

The cost of the average 30-year mortgage in the US has risen from 5.5pc last summer to 6.43pc this week. The housing boom is now the mainstay of the US economy. Last year Americans withdrew the equivalent of 6pc of GDP in home equity from their houses, spending most of it on daily bills, holidays and consumption.

Long-term yields remained near historic lows during 2005 despite a string of rate increases by the US Federal Reserve. The muted response of the bond markets dulled the impact of Fed tightening, prompting ex-chairman Alan Greenspan to talk of a "conundrum". "The conundrum just died," said Paul McCulley, an economist at the world's biggest bond trading company Pimco.

Joachim Fels, an economist at Morgan Stanley, said the conundrum had been caused by the easy money policies in Japan and Europe, creating a flood of global liquidity that continued to overrun the US credit markets long after the Fed began raising rates.

He said synchronised tightening across the world was now leading to bond sell-offs everywhere, with "nasty implications" for risky assets. "I think it is time to hunker down," he said. The bank is predicting a 7.9pc fall in European stock markets over the next six months.

JP Morgan Chase is forecasting a 13pc fall in Amer-ica's S&P 500 stock index, and 12pc fall in the FTSE 100. "Our big concern is the combination of rising bond yields, sustained high energy prices and weakness in US housing," said Abhijit Chakrabortti, the global equity chief.

Analysts said the surge in bond yields may have been accelerated by panic selling of Treasuries by hedge funds and US investment banks.