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The US 10-year Treasury bond yield has now broken out of a 26-year trendline. If the move is sustained, that must - sooner or later - be very bad news for Wall Street-correlated equities as well as credit spreads, says CLSA’s Christopher Wood in the latest issue the bank’s (subscriber) newsletter, Greed & Fear.

“The bigger the spike in US bond yields, the more ultimately deflationary it will be due to the sheer scale of leverage in the system”, says Mr Wood. In the meantime, one explanation for the bond move is a growing focus on the double whammy posed by both rising energy and rising food prices, he notes. This has the potential, if sustained, to cause the Fed formally to shift its “inflation” target away from the “core” concept in response to growing political pressures. “Such a move would be very bad news indeed”, he says, noting that imported inflation pressures also seem to be growing in the US.

But, he says, there is one place that rising bond yields should prove rather more bullish for equities, both from a relative return and an absolute-return basis: Japan. Greed & Fear has been checking out the mood in Tokyo, “the world’s serial underperformer from a relative-return standpoint in the recent past, even if the Topix index has only essentially marked time since the monster up-move in the second half of 2005″. From the standpoint of the international investor, the relative underperformance has been further undermined by the chronic weakness of the yen, says Mr Wood.

The comparisons are stark: “Thus, the Topix has risen by only 2.1 per cent in dollar terms since the beginning of 2006, while the MSCI AC World Index and the MSCI Europe index have risen by 28 per cent and 40 over the same period

If the Bank of Japan harbours a genuine desire to raise rates [despite political opposition], “the political cover to do so has of late increased dramatically”, notes Mr Wood. As the consensus is “no longer looking for interest-rate cuts in America this year”, this makes it easier for the BoJ to resume tightening again, as does the recent increase in bond yields globally including in Japan, he reasons.

The central bank is concerned that if it does not get on with normalising rates, “it may soon be forced to do so by intensifying foreign pressure”, says Mr Wood. “The BoJ is increasingly uncomfortable with the escalating capital outflows given that the Japanese retail investor forms a key part of the yen carry trade. Indeed with further interest-rate hikes expected elsewhere, the risk is that the capital outflow turns into a tsunami if the BoJ remains on hold.”

The conclusion? Investors should assume that the BoJ will raise rates this summer and probably again by the end of this year unless there is some global external shock. Greed & Fear, he says, is of the view that the Japanese bank stocks are only likely to react fully to the tightening when it actually occurs. It is now also time to sell or at least underweight the property stocks.