Rising bond yields -- good news (2)

I've been predicting much higher Treasury yields for most of this year, and I recall saying in a comment, in response to a reader's question, that when 10-year Treasury yields reached 4% that would be a good sign that the market had accepted the fact that the economy was in recovery mode. And that's essentially where we are today.

I've also maintained that rising Treasury bond yields were a good thing, and not a threat to the economy as so many seem to be arguing these days. That's because yields have been rising mainly because the economy is recovering instead of collapsing, and deflation is essentially dead; recall it was the fear of depression and deflation that drove 10-year yields to 2% at the end of last year. We've come a long way since then, and that's a good thing. We're not sliding into a depression, were beginning to grow again.

I've also said that there was a Perfect Storm developing that could send T-bond yields sharply higher: a recovering economy, rising inflation, and massive sales of Treasuries to finance Obama's trillion-dollar deficits. That sounds pretty scary, but the storm could bring with it the much-needed realization on the part of politicians and the press that we have got to rein in the spending impulse that seems to have rendered every Democrat in Washington an Obama-zombie. We don't need to spend $800 billion in stimulus money, because the economy has recovered on its own. We don't need to goose the federal budget either. And with social security and medicare already facing giga-deficits in coming years, we don't need—and most certainly can't afford—to expand federal healthcare spending any further.

Back to yields: thanks to a significant narrowing of credit spreads, the 2 percentage point rise in Treasury yields this year hasn't resulted in any significant increase in borrowing costs for the private sector. Junk bond yields have fallen by roughly 6 percentage points since the end of last year, and investment grade bond yields are roughly unchanged. Mortgage rates are up from their all-time lows, but they are still well below the levels that prevailed during the housing boom. I don't see why 5.75% fixed mortgage rates have to be a threat today, considering that they averaged 6.65% over the past 13 years, according to BanxQuote. Consider also that yields are up in nominal terms, but real borrowing costs (after adjusting for inflation) are still relatively low, and could go lower if inflation rises.

What the Fed needs to do is to start withdrawing the $1 trillion it has added to the money supply, as Art Laffer explains in his WSJ op-ed today. If they took credible steps to avoid the huge rise in inflation that threatens, that would boost confidence and boost the dollar, and that would result in more investment and a stronger economy. This is not the time to go wobbly in the face of higher yields.