The stock market has been weak based largely on the prospect of higher long term interest rates. The question is whether this rise in rates is fundamental in nature or indicative of tightening liquidity?

Michael Kahn in Barrons.com demonstrates that long term interest rates are definitely on the rise in the short term. However near 5% the situation becomes muddier. Kahn asserts that a concerted rise above 5% would do serious damage to stock prices.

James Hamilton at Econbrowser posits that higher inflation expectations and higher than expected economic growth have lead to a rise in long term rates.

The conclusion that the economy is stronger flies in the face of the following. TickerSense has a nifty graph showing the relative strength of the economy based on how economic reports come in according to expectations. By this measure the economy rolled over near the beginning of 2006.

Based on this it would seem that the liquidity argument should hold sway. Rising rates in Japan may be indicative of a global contraction in credit. While only time will tell it will be interesting to see how far (and how fast) long term yields rise in the short term. The stock market as a whole has not had to deal with a concerted rise in yields for quite some time. This could also lead to a long anticipated rise in volatility. Keep your eyes open.

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