March 08, 2006
Rising long-term yields
The yield on 10-year U.S. Treasuries is up almost 40 basis points so far this year, which means it's been gaining on the fed funds rate and reducing the prospect of full inversion of the yield curve. Why have rates been going up?
Part of the answer appears to be that investors are a little more worried about inflation. For example, the yield on the 2015 1-5/8 Treasury Inflation-Protected Security is only up 12 basis points for the year, suggesting that while there has been some rise in the real rate, a bigger part of the move has been an increase in inflationary expectations.
It's also interesting to note that the yield on Aaa-rated corporate debt has not risen quite as much as the Treasuries, either, so there has been a modest degradation in the particular attractiveness of Treasury debt to some investors. One wonders whether the fact that the Treasury is forced to resort to accounting games in order to make payments on the debt could have any effect on yields. This is sadly a familiar ritual in American politics-- Congress votes to spend X, votes to collect taxes Y, but then declares loud indignation about the fact that the government is then required to borrow X - Y. Their hope is that American voters will be fooled by their speeches but that foreign investors will recognize the posturing as pure bombast.
If we focus just on the dramatic moves of the last week, however, all the yields seem to have moved up together, so the most recent developments have shown up as an increase in real interest rates across the board. I'm inclined to throw in my hat with Dave Altig, Tim Duy, and William Polley in reading this as suggesting that investors may have revised upward their expectations of near-term real economic growth. Specifically, whatever the pessimistic concerns on the part of bond market participants were that may have been contributing to the yield curve inversion are perhaps now lightening at least a bit.
Posted by James Hamilton at March 8, 2006 08:18 PMdigg this | reddit
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Tracked on March 9, 2006 05:28 AM
I've been reading that the economies of Europe and Japan are "heating up".
Japan is due to tighten their rates by moving off their zero interest rate level.
The European Central Bank just raised rates to 2.5%; this on the heels of other recent hikes.
The yield hike in the 10-Year Treasury seems to be a natural reaction to these events; as the interest rate spreads between Europe/Japan (tightening) & the US (status quo) narrow, doesn't it make sense that a 10-Year yield upturn make our treasuries that much more attractive because they offer better rates of return and are deemed safer?
Posted by: Grzegorz at March 9, 2006 03:28 AM
I think Grzegorz has a point. Alternative investments are rising in attractiveness which does put pressure on US government bond yields. On the other hand, the yield curve is still slightly inverted when you would expect it to be rising with longer maturities. Since the prices for longer term Treasuries are set by market forces, I think investors foresee lower inflation long-term, or do not believe that inflation is as high as the Fed thinks it is. Put another way, the Fed may be overreacting and pushing short-term yields higher than warranted.
I think the measurement of inflation is far less precise than the experts make it seem. When policies are driven by fractions of a percentage change (and inflation is the first derivative of the price level), small differences in measurement of the price level yield significantly large differences in inflation, especially when measured on a monthly basis.
Professor Hamilton - thanks to you for your efforts in maintaining this interesting and very civilized forum.
Posted by: Rich Berger at March 9, 2006 05:32 AM
What we may be seeing is the down-side of the global savings glut thesis. Weak foreign growth kept foreign rates low and allowed the US to finance its deficits cheaply. But now foreign growth is flowing into higher US rates.
Is the Greenspan condumdrum turning into the Bernanake condumdrum?
Or is the real cost of the large US deficts and dependence on foreign capital a sharp reduction in our ability to conduct an independent monetary policy?
Posted by: spencer at March 9, 2006 09:59 AM
As a non-investor it is kind of funny to read the investment boards responding to these moves. These cheery-looking upward moving graphs are bad news for bond investors. They are saying that the bond market got "hammered" this past week. When rates move up, the value of existing bonds goes down. Bond holders look at those charts upside-down.
As far as the reason for the move, when the market thought a recession was possible, they anticipated rates to drop. Now they are worried about inflation, so they anticipate rates to rise. This raises the question: what happens when there is both a recession and inflation? Can't happen? I don't know about that!
One more data point: the Los Angeles Times nationwide poll out yesterday asked respondents what they thought the Fed would do with interest rates this year.
48% thought they would keep raising interest rates throughout the year, compared to 30% who thought they would soon stop raising them and keep them level (and 9% who thought they would start cutting). I tend to give a lot of credibility to people on this issue because changes in interest rates are important to the financial lives of ordinary people.
Posted by: Hal at March 9, 2006 11:11 AM
How do you manage to be a "non-investor"?
Posted by: Rich Berger at March 9, 2006 12:10 PM
> Professor Hamilton - thanks to you for your efforts in maintaining this interesting and very civilized forum.
Yeah. It is fascinating how much higher the interest in actual dialogue, or in just turning an idea over for its own sake, is in this blog than in others that seem to all appearances identical. The credit has to belong to Professor Hamilton.
Posted by: Fred Hapgood at March 9, 2006 12:27 PM
Could it be that the 10 year T note has competition from (the new kid in the block) the30 year T Bond?
Was the conundrum created by having bond buyers line up to one booth only; the 10 year T note?
Posted by: Joe Rotger at March 12, 2006 08:13 PM