Friday, April 2, 2010

Yields rise as the economic outlook improves


Yields on 10-yr Treasury bonds are now just 1 basis point shy of their highest level in the past year. As I've said before, these yields are best viewed as a barometer of the market's expectations for future economic growth, and I've indicated that with the shaded areas on the chart. At the end of 2008 yields plunged to 2% as the market priced in expectations for a deep depression and deflation. Today the market is pricing in some growth, probably on the order of the 2-2.5% growth forecasts that are common to those who believe in an extended "new-normal" period of sluggish growth.

It's my impression that most people worry that higher bond yields will choke off growth, but I thing it's the other way around. Growth fundamentals are improving, so bond yields are rising. That's only natural, since Treasury yields need to compete with the returns that can be generated by the economy, and those returns are, in turn, a function of the rate of economic growth. It would take bond yields of at least 6 or 7% and a concerted effort by the Fed to tighten before rising interest rates might prove harmful to growth.

The jobs growth we have seen so far this year is very welcome, but it does not yet signal that growth will be robust. It takes about 130K new jobs per month just to keep up with the normal expansion of the labor force, and more than that to bring about a decline in the unemployment rate. On the margin, the changes we are seeing are definitely positive, and there is likely to be further improvement in the pace of job creation later this year. On balance I think this adds up to a positive for the market, since I think the consensus is still somewhat pessimistic about the prospects for future growth.

5 comments:

Sunshine said...

Scott -- This modest growth rate of 2-2.5% is what you believe is indicated by Treasury yields. Elsewhere, I believe you referred tp a V-shaped recovery. Which is it? Modest growth a V-shaped recovery?

Scott Grannis said...

What the market believes is very different from what I believe. That is the key to being bullish. I think the market is priced to 2-2.5% growth. I think we will see growth of 3-4%. I think this because of all the V-shaped recoveries I see in many sectors of the economy.

DaleW said...

It has been interesting to see TIPS rates go up the last three weeks while breakeven rates (both on 10-years) have stayed virtually flat. I take this to mean better real growth without any marginal inflation expectations -- no wonder equities have had a nice three weeks.

Scott Grannis said...

Dale, your interpretation is correct.

marry said...
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