Before Congress cut the tax on dividends and capital gains in May, critics claimed it would have little impact on the stock market. Yet stocks were already rising in April in anticipation of higher after-tax returns in the future. The rally to date has already been impressive, despite recent setbacks. The Dow is still up nearly a fourth from this year's low of 7,286 on March 10. The NASDAQ is up even more.

Such conspicuous success embarrassed many who predicted failure. As usual, defensive themes soon emerged among financial reporters who specialize in looking for clouds behind every silver lining. Some claimed the market's rebound was an inexplicable "mania," destined to collapse. Others tried changing the subject, putting undue emphasis on such notoriously misleading indicators as payroll employment and consumer confidence.

The most common journalistic device to convert investor success into political failure is to fret about the fact that long-term interest rates are up from their record lows. This often involves such quackery as pretending the bond market suddenly noticed budget deficits in August that it failed to see in June. And the supposedly unsettling news always involves ominous warnings that higher interest rates threaten the continuation of hectic mortgage refinancing. Refinancing is said to be critical to consumer spending, which, in turn, is ineptly described as the cause rather than consequence of prosperity.

This story is not new. On March 24, James Grant wrote in The New York Times that, "Buoyed by war news and easy money, (the stock market) has strung together eight days of gains, the most since June 1997. But the bond market, too, has noticed. Interest rates have climbed, with the 10-year Treasury note now above 4 percent, up from a low of 3.56 percent only a few days ago. Mortgage rates have followed suit, a shift that imperils the glorious mortgage refinancing boom."

By the end of that day, ironically, war news was more plausibly said to be

the reason stocks suddenly fell 3.6 percent -- pushing the Dow down to 8,215, while the yield on 10-year Treasury notes fell to 3.97 percent. That simultaneous decline in stocks and bond yields was also nothing new. Long-term interest rates had earlier bottomed when stocks did on March 10. In fact, bond yields then fell to the lowest level since October 2002, which (by no coincidence) was yet another record low for stocks.

Fears about the economy, in short, have often driven people out of stocks and into Treasury bonds. Falling stocks prices have often been associated with falling bond yields. So how can anyone now feign surprise when good news for the economy has the opposite effect -- raising both stock prices and bond yields?

When long-term rates rise more than short-term rates, that is called a steepening of the yield curve. Such steepening of the yield curve is one of the most reliable tools economists have for predicting an improving economy. For one thing, a wider spread between rates on loans and deposits makes banks less timid about lending to small businesses. Continued...