Wednesday, May 13, 2009

Fed: Higher Treasury yields would be a positive sign

Well, it seems the Fed and I see things the same way. In a Bloomberg article today, I read that "The Federal Reserve considers the recent jump in Treasury yields more as a reflection of a better economic outlook than a signal it needs to step up purchases of U.S. government debt."

Fed policy makers committed to buy as much as $300 billion of Treasuries over a six-month period in their March 18 Open Market Committee statement. The aim was “to help improve conditions in private credit markets,” the FOMC said.

“The statement is pretty clear,” Richmond Fed President Jeffrey Lacker, who was the first FOMC member to vote for buying Treasuries this year, told reporters May 8. “It doesn’t say anything about a U.S. Treasury yield” as a target, he said after a Washington speech. “I would urge people to take it at face value.”

In short, the Fed would buy Treasuries not to keep Treasury yields low, but to supply liquidity to the market. If the economy improves, and that sure looks to be the case, then higher Treasury yields would be a very positive sign and the Fed would be delighted, not concerned. This is a very bullish development, since it reduces the risk of inflation. If the Fed tried to keep Treasury yields from rising in an improving economy, it would almost surely fuel unwanted inflation.

This is also another good reason to avoid investing in Treasuries, unless you are pretty sure or very afraid that the global economy is going to collapse: The Fed is not going to try to support the Treasury bond market. And they really couldn't, even if they tried, because it is so big.

Full disclosure: I am long TBT (and thus short Treasuries) at the time of this writing.

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