Barclays think bonds aren't cheap enough yet. Ned Davis Research views them as a real alternative to stocks

The global bond selloff has been "relentless," according to Barclays, but no government is prepared to consolidate fiscally yet and rein in spending

Amid a global bond market selloff, the U.S. 10-year Treasury note yields 4.70%. They are cheaper than they have been for years, leading Barclays strategists to ask: Is it time to buy?

The answer, according to Ajay Rajadhyaksha and Anshul Pradhan, is "No it isn't ... because the forces pushing yields higher are not exhausted." However, Ed Clissold, chief U.S. strategist at Ned Davis Research, disagreed. He found that, after the recent spike in bond yields, only 4% of S&P 500 SPX constituents offer a higher dividend yield than the 10-year note BX:TMUBMUSD10Y. "For investors looking for a consistent income," he wrote," the bond market now offers a reasonable alternative to the stock market."

Fewest S&P 500 stocks' dividend yields above T-note yield in nearly two decades

The backup in U.S. Treasury yields is far from unique. The Barclays team, in a Thinking Macro research note published Monday, said that Japan's 30-year BX:TMBMKJP-30Y debt trades above 4% for the first time and that French bonds, or OATS (Obligations Assimilables du Trésor). France's BX:TMBMKFR-10Y trades at a spread to German bunds BX:TMBMKDE-10Y (plus 87 basis points) that would have been unthinkable three years ago.

Looking at the U.S. 10-year yield, Barclays pointed to two factors driving its fair value. The first is "what the market believes the average short-term interest rate will be over the next decade," while the second is the "additional compensation investors require for bearing the uncertainty around that path."

Encapsulating this more neatly, Barclays said that "the U.S. 10-year yield is the market's estimate of the average federal funds (FF00) rate over the next decade, its long-run, neutral policy rate, plus term premia."

At present, Rajadhyaksha and Pradhan assume that the neutral policy rate is 3.65%, roughly in the middle of the current Fed funds target rate of 3.5-3.75%. They found that the spread between that rate and the U.S. 10-year yield is 130 bps. Adding the two together produces a fair value of 4.95%, only 25 bps higher than the current market rate. Subtract the years of zero interest rates in the 2010s, and the spread is generally 100 basis points. That puts fair value pretty much at where the market is.

What troubled Barclays, however, is the stickiness of inflation and that the Fed has missed its 2% target for six consecutive years. What troubles Barclays almost as much is fiscal term premium, the concern that governments are issuing too much debt, supply is overwhelming demand and investors are demanding a higher premium to hold duration while sovereign balance sheets deteriorate.

This factor zoomed into focus last week as the U.S. national debt crossed the $40 trillion milestone. Barclays worries that despite this increasingly unmanageable debt, "nothing is changing." There is, it appears, "no political will for fiscal consolidation." Japan's JGB yields BX:TMBMKJP-10Y now offer meaningful competition for U.S. debt and when the largest holders of U.S. Treasurys are Japanese institutions, that's a problem. The financing requirements of the AI capex splurge are also pushing yields higher, leading Barclays to conclude that "U.S.10-year yields still aren't high enough to compensate for these one-sided upside risks."

Some equity investors may think differently, though. Clissold said that the era of TINA (There Is No Alternative) for equities has evolved into TARA (There Are Real Alternatives) as rates have moved structurally higher in the U.S. For instance, in 2016, 63.4% of S&P 500 stocks yielded more than U.S. 10-year notes. Now it's less than 4%, the lowest since 2007.

-Jules Rimmer