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Just when stock investors seemed ready to throw off three years of gloom and doom over slack global growth, rising geopolitical tensions and soggy corporate profits, Wall Street has found a new worry: Bonds.
U.S. Treasuries prices plummeted on Monday, catapulting bond yields to seven-month highs -- with the yield on the 10-year note climbing well above 4 percent --- as growing confidence that the economy is poised to rebound in the year's second half year prompted investors to dump bonds.

More optimism about the economy should bode well for stocks, right?

Not necessarily, analysts say.

Rising bond yields could choke economic growth by hiking borrowing costs, crimping the rebound so many stock investors were betting on when they bid stocks up sharply this spring.

"If that exit out of bonds happens too rapidly, then you're going to see those rates continue higher, and that's going to stall the economy, that's going to stall profits, that's going to hurt consumption, and you can forget about equities continuing on a cyclical bull" market, said Stephen Bartholow, chief investment officer of Carrett & Co. LLC.

Adding to that is the worry that higher interest rates could lure some investors looking to secure solid returns, especially in an environment where the recent rally in stocks seems to have run out of steam.

The Standard & Poor's 500 index <.SPX> is still up about 23 percent from its 2003 low hit on March 11, but it has been bobbing mostly sideways for the past month. The index is down about 35 percent from its all-time high hit in March 2000.

REFI BUST?

Bond yields help determine mortgage rates, and higher mortgage rates could slow home sales and refinancing -- two bright areas in the otherwise spotty economic recovery.

It is widely acknowledged that the severity of the recent recession was cushioned by consumer spending, which was fueled by home owners refinancing mortgages at lower interest rates.

A slowdown in mortgage refinancings would take business from financial companies that benefited from the recent boom.

Concerns in recent months about lingering economic weakness and the threat of deflation -- a widespread decline in prices that can take a bite out of corporate profits -- helped fuel a significant bond rally.

Sentiment turned, however, after Federal Reserve Chairman Alan Greenspan played down the danger of deflation and the need for unconventional policy measures to shore up U.S. growth in his semi-annual testimony before Congress earlier this month.

"There was a foregone conclusion that we'd have low inflation, and in some cases, deflation, and you're not hearing that talk anymore," said Peter Gottlieb, president of Gottlieb Investment Management. "Interest rates continuing to go higher presents competition for stocks, in terms of returns."

By: Elizabeth Lazarowitz