Monday, March 1, 2010
I first wrote on this subject 10 days ago. The chart above shows the yield on 3-mo. T-bills, and as should be obvious, that yield has been rising for most of the year. We're still just talking about basis points, of course (with the current yield just shy of 0.13%), but the upward movement on the margin is what's most important. 3-mo. T-bills are the gold standard, if you will, of risk-free investing. When yields were close to zero at the end of last year it was a sign that investors worldwide were almost totally risk-averse. Now things are changing, and risk aversion is slowly fading. This has to do with rising confidence, and with increasing signs that the economy continues to expand.
When cash, which is ultimately the alternative to anything risky, yields zero then the only sensible explanation is that investors are basically terrified of risk and will forgo all rewards in exchange for safety. If you are holding cash these days that you would otherwise be investing, then it can only mean that you are extremely worried that risk assets will decline in value. By inference, you are also extremely worried that the economy will turn south, for whatever reason (e.g., the dreaded "double-dip" recession).
I'm sure many will argue with me that cash yields are almost zero because the Fed wants the Fed funds rate to be almost zero. While the Fed certainly has a lot of sway over short-term interest rates, the Fed often looks to the market for signals as to its next move. Meanwhile, the Fed is just as terrified of a double-dip as the market is, which is again the only reason they would want interest rates to be zero.
The longer the economy shows signs of recovery, the more pressure there will be on bill yields to rise. Similarly, the more we see bill yields rise, the more confident we can be that recovery is here to stay. I fully expect to see bill yields continue to rise, and for the Fed eventually to follow the lead of the market and raise the target for the funds rate to 0.5% as a first step. Rising interest rates won't be a threat to the recovery, they will be in response to the recovery, and that will be very good news indeed.
Posted by Scott Grannis at 8:29 AM