Will US yield spike derail tapering plans?
A continued selloff in U.S. government bonds could force the Fed to rethink when and by how much it tapers monetary stimulus, according to one strategist, after 10-year Treasury yields spiked to a two-year high on Thursday.
"The rapid rise in yields could make the Federal Reserve nervous especially if it nears the 2.9 percent mark," said Kathy Lien, managing director of FX Strategy at BK Asset Management.
"If come September, 10-year Treasury yields are at 3 percent or higher, the amount of reduction in asset purchases could be smaller and the Fed will downplay expectations for additional tapering. December is still an option but its proximity to the holidays makes it a less desirable time to reduce stimulus than September," she added.
The 10-year yield rose above 2.8 percent, the highest since August 2011, after positive jobless claims data heighted expectations that the Federal Reserve is close to scaling back its bond purchases, prompting investors to decrease their debt holdings. Initial claims for state unemployment benefits dropped 15,000 to a seasonally adjusted 320,000, the lowest level since October 2007.
In a meeting with reporters Thursday, St. Louis Fed President and Federal Open Market Committee (FOMC) voting member James Bullard said rising yields raise some "concern."
The rapid ascent in Treasury yields, which have climbed around 120 basis points over the past three and a half months, has unnerved investors and sent U.S. equities tumbling overnight. Higher yields imply heftier long-term borrowing costs for corporates, which is negative for earnings.
For Richard Clarida, global strategic advisor at the world's largest bond fund PIMCO, however, the recent spike in yields is not a concern. In fact, he believes rates will be lower by year-end than where they are at the moment.
(Read more: 6% Treasury yields? May come sooner than you think)
"Most of the news on tapering is probably more than priced in to Treasurys," Clarida said. The yield on 10-year Treasury note currently stands at 2.76 percent.
"So, if the Fed doesn't taper in September, or they taper by less than expected, or they change their language, we think bonds are set up to rally from these levels," he said.
Markets are pricing in that the Fed will reduce its asset purchases by $20 billion both in September and December, according to Clarida.
"It's hard to see them tapering by more than is priced in right now," he said.
(Read more: Worst case for Fed taper: mere market 'indigestion'?)
Clarida is not alone in his bullish outlook for U.S. government bonds. Jessica Hind of Capital Economics, an economic research firm, forecasts the yield on the 10-year will fall to 2.5 percent by the end of 2013.
"We think investors may have run ahead of themselves. After all, even if the Fed does start to scale back its bond purchases in September as we expect, interest rates will remain very low for an extended period of time," she wrote in a note on Friday.
—By CNBC's Ansuya Harjani; Follow her on Twitter @Ansuya_H