10-year Treasury reaches key 3% level

NEW YORK -- The 10-year U.S. government bond touched the key 3% level on Thursday as investors continue to price in less bond purchases from the Federal Reserve and an improving U.S. economy.

Interest rates are starting their push higher to more normal levels after falling to historic lows in the aftermath of the 2008 financial crisis.

The benchmark 10-year Treasury note, which hit a 2013 low of 1.63% in early May, has not closed above 3% since July 25, 2011, according to Yahoo Finance. It briefly ticked above 3% Thursday for the first time since September before retreating to 2.99%.

How markets react to rising bond yields depends on how fast they go up and why they are going up, says Scott Anderson, chief economist at Bank of the West.

"If long-term interest rates rise too rapidly, we could see stronger headwinds develop in housing, autos and business spending, (which) could temper our optimistic economic outlook," says Anderson. "Gradual rate increases that are matched by stronger sales, and improved investment opportunities are not as concerning as interest rates that are on the rise because the Fed is no longer a major buyer in the U.S. Treasury market."

So far, stock investors have shrugged off rising rates, preferring to focus on the positives related to a stronger economy. Wall Street has also been soothed by comments from the Fed that they will remain easy with policy, despite its move to start reducing stimulus. The Dow Jones industrial average is riding a five-session winning streak and closed at its 49th record high of the year on Tuesday. It is trading higher again today.

"Bernanke has set expectations pretty high that the Fed will remain accommodative," says Alan Skrainka, chief investment officer at Cornerstone Wealth Management.

In recent years, risk-averse investors afraid of the stock market have funneled massive amounts of cash into bonds and bond funds. In addition, there has been unprecedented intervention in the U.S. government bond market b! y the Fed. The nation's central bank bought $45 billion of long-term government bonds each month in 2013, a strategy designed to stimulate the economy by keeping borrowing costs low.

Heavy buying from Main Street and the Fed bolstered the demand for 10-year Treasuries, which pushed prices up, and yields, which move in the opposite direction, down.

But the investment thesis for bonds is starting to change. The biggest change is that the Fed said it will start to reduce its bond purchases beginning in January. It will trim its Treasury purchases by $5 billion next month to $40 billion, the first move in dialing back its asset purchases. The Fed has hinted that it might stop buying bonds altogether later in 2014.

In addition, the fear factor has come out of the bond market as well, due in large part to signs that the U.S. economy is finally picking up steam and may have enough juice to grow on its own without as much Fed stimulus.

Not only have big-ticket items like homes and autos picked up sharply in the past year, so to have broad measures of overall growth in the U.S. economy. The government, for example, in its final revision of third-quarter economic growth, said Friday that GDP rose at an annualized rate of 4.1%. The pick-up was driven in large part by greater consumption on the part of consumers, which accounts for roughly two-thirds of growth.