Wednesday, June 29, 2011
Just five days after I posted that "with 2-yr yields and confidence in the future at record lows, the potential rewards to being optimistic have almost never been better," bang: Treasury yields have shot higher, reducing the price of 10-yr Treasury bonds by 2.1% while wiping out two thirds of a year's worth of coupon yield, and equities are up over 3%.
The most visible trigger for this remarkable turnaround is progress towards avoiding a Greek default, but I suspect there are other factors at work as well. I note that the breakeven inflation rate on 5-yr TIPS has jumped by 21 bps in the past five days, as nominal yields have risen 34 bps and real yields have risen by only 12 bps; this signals that half of the rise in nominal yields is due to rising inflation fears, while the other half is due to stronger growth expectations. I note also that crude oil futures are up almost 5% in the past five days, and the Vix index has dropped almost 18%. All of this leads me to the conclusion that, as I suspected, the market was depressed more by fear than by fundamentals.
What it all boils down to is this: Treasury yields are a good barometer of the market's growth expectations, and the market's Phillips Curve logic makes growth and inflation expectations move hand in hand. Yields have been trading at very low levels, suggesting that the market had become deeply pessimistic about growth. Higher yields are thus an excellent sign that the outlook for the economy is improving. Higher yields faster, please.
Posted by Scott Grannis at 11:03 AM