Monday, December 28, 2009

Treasury bond yields rise, and that's good

Yields on 10-year Treasury bonds are a handy barometer of the market's economic optimism. Yields plunged late last year to 2%—a level not seen since the Great Depression—as the market came to fear that the economy was headed for a severe depression and deflation. Yields are now headed back 4%, which—in my view—is a level consistent with an economy that is only capable of managing meager growth with very low inflation. Yields would have to go well over 4% and approach 5% before I would say that the market's expectation of our economic future was anything close to "normal."

So the market is still gloomy, but not catatonic as it was a year ago. Rising bond yields reflect improving sentiment on the margin, and that goes hand in hand with the Fed moving sooner, rather than later, to reverse its quantitative easing and push short-term interest rates higher. This is not a threat to the economy, this is a natural consequence of the economy doing better than expected. The Fed would need to raise short-term rates to at least 5% before anyone could argue that money was tight enough to threaten the economy. Historically, it has taken one or more years of a real Fed funds rate of 4% or more before the economy succumbs to tight money and slides into a recession.

And since the yield curve today is as steep as its ever been, we know the market is already prepared for significantly higher short-term interest rates over the next few years. The real problem would be if the Fed failed to raise rates in a timely fashion, since that would likely result in higher inflation and eventually another round of tight money and a protracted recession.


alstry said...


Is it possible rates are going up because it is getting harder and harder to finance our unprecedented deficit...your thoughts on this would be appreciated as Obama doesn't seem to want to stop spending money that doesn't exist.

If you think about it, why are Federal workers even getting paychecks where if they worked for a private company they would be fired and trying to collect unemployment. Isn't government spending supposed to be a derivitive of the taxes paid by the private sector?

It appears that it is beginning to crowd out dollars for trade and shipping on the margin.

Dec. 28 (Bloomberg) -- A 26-mile-long line of idled oil tankers, enough to blockade the English Channel, may signal a 25 percent slump in freight rates next year.

The ships will unload 26 percent of the crude and oil products they are storing in six months, adding to vessel supply and pushing rates for supertankers down to an average of $30,000 a day next year, compared with $40,212 now, according to the median estimate in a Bloomberg News survey of 15 analysts, traders and shipbrokers. That’s below what Frontline Ltd., the biggest operator of the ships, says it needs to break even.

Игры рынка said...

if you did a simple study on how yield curves flatten you would see that in all case in observable history they flattened via long end. Is this time different?

Scott Grannis said...

Actually, in virtually every case of yield curve flattening, short rates move up much more than long rates move down. The classic monetary tightening pattern involves a Fed that lifts short term rates, while long term rates are relatively unchanged.

Brian said...


Many would agree that the housing market will have to gain considerable momentum before a lasting recovery can take hold. With that said if Treasuries were to rise 100 bps across the board mortgage rates would rise considerably as well. Would such a situation pose a considerable threat to the recovery?

Scott Grannis said...

Brian: I'm not sure I would agree that housing will be the key driver of this recovery. Recall that housing starts never declined by much prior to the 2001 recession, and never rose by much during the next few years. Of course, the residential construction market has shrunk to an unprecedented degree relative to GDP, so it's entirely possible that we will see housing starts rising by leaps and bounds over the next 3-5 years. But I think the essential building blocks of this recovery are already in place: the financial markets have largely recovered from the shock of last year; confidence in the banking system has returned; monetary velocity is picking up; the global economy is rebounding strongly; the labor market is beginning to stabilize; corporate profits are rising. To name just a few, plus all the V-signs I've been highlighting for months.

A substantial recovery in the housing construction market will occur at some point in the not too distant future, and it will be driven by a nationwide shortage of housing units. Construction will have to pick up, and by that time the economy will be stronger, incomes will be higher, and money will likely be plentiful. A 100 bps rise in mortgage rates is very unlikely to derail this process. Indeed, rates are likely to rise because of the economy and the housing market getting stronger.