and Jim & Milton – “too much money chasing too few goods” .. I think there is another inflation side – human spirit to hang on & make payments for the family .. there is a power in hands & feet (still)

You’re right that a credit problem would cause interest rates to rise. But that would cause ALL interest rates to rise. Specifically, the yield curve would flatten as 40% of Government debt matures in the next year. It would cause all forms of Government debt, like TIPS and Federal Agency debt to rise in yield. It would cause “Build America” bonds to rise in yield (as they have a guarantee from the Federal Government). etc.

However, this is NOT what we are seeing. Demand for short Treasuries is booming. Last week’s T-Bill auction drew a record bid-to-cover ratio of 6:1. The yield curve is steepening and Agency and Build America bonds maintain their tight spread to Treasuries.

When you drill down you see that long-term interest rates are rising, not short-term (steepening yield curve) and TIPS are outperforming Treasuries (meaning implied inflation rates are growing). All of this is consistent with heightened inflation expectations.

moruobai :

Milton Friedman was correct when he said that inflation is “too much money chasing too few goods.” Those that argue that inflation is under control because of excess capacity in the system do not understand how it works. It’s all about money.

The reason inflation has not come back (yet) is the transmission mechanism of all this money, the banking system, has been dysfunctional. Now that it on the verge of healing (or has healed) the market sense that all this money will not create inflation, despite what plans Bernanke has to withdraw the liquidity. This is why the markets are signaling inflation’s return. They see it coming.

Yes, you care correct, the Fed has been trying to reflate and their efforts are about to be successful. My fear, and I believe the market’s fear, is we are about to see the full burnt of reflationary policies take hold. What you are assuming is that inflation is going to be spread about equally. If the inflation rate (headline CPI) spikes to say 7%, that wages will go up 7%, stocks will tack an extra 7% on their returns, banks will increase borrowing rates by 7% and so on. It does not work that way. Wages and returns will lag behind inflation and everyone loses. Banks will see their delinquency rate decline but will get paid back in depreciated money. They will be net losers.

Bottom line, saying inflation’s return is a good think is like say the junkie in the corner having convulsion and puking blood is good as he is getting the drugs out of his system. In a VERY narrow technical sense you’re correct but you’re going to absolutely hate being correct on this one.

*I think every time we refer to Bernanke we should refer to his award.

Maybe both are wrong and rates are going to 7%…but MS would be less wrong.

Also, talking about how bad 2009 was for bonds is a little meaningless without the context of late 2008, when rates fell off a cliff. Net net, rates are back to where they’ve spent most of the last two years.

I think that statement has it totally backwards. Bernanke spent his life studying the Great Depression and concluded that to prevent a second one from occuring he 1) couldn’t let the banks fail and 2) had to keep the money supply from collapsing. He’s given several speeches about “making sure deflation doesn’t happen in the US” and he has often referenced his “electronic printing press”. This guy was born to be in the position he is currently in.

Generating inflation is the whole point of the Fed’s (and Treasury’s) actions. They are trying their damndest to reflate the housing market (and the stock market!) so consumers don’t default owing to negative equity and banks don’t have to take the writedown. If yields on the 10-year reach 5.5% this will mean Bernanke has succeeded, not failed. This will mean Bernanke beat deflation. Put it another way, rock bottom yields are what Japan has achieved.

I know I personally feel a lot better with yields at their current level than I did when yields were testing the 1 handle a few months ago!!

“Last year (2009) there was almost no net debt issuance between corporates and Treasuries, adjusted for Quantitative Easing. Indeed, it was only about $200 billion. That this sort of extreme measure was required to prevent a bond market implosion is rather telling. But what’s worse is what’s on the calendar for 2010 – nearly $2 trillion of net issue, duration-adjusted. A huge part of this is Treasury debt, and there the news is even worse, as there’s a serious duration problem in this regard – nearly half (about 40%) has a maturity of one year or less. This means that Treasury must roll over that debt – about $3 trillion worth – “or else.”

Ask the asset-backed commercial paper market and auction-rate securities folks what happened to them when their short-duration paper couldn’t be rolled on commercially-reasonable terms. Then extrapolate that to what happens to Treasury if (or possibly when) they’re unable to roll $3 trillion plus issue another $2 trillion on top of it to fund the deficit.”

http://market-ticker.denninger.net/archives/1793-Where-We-Are,-Where-Were-Heading-2010.html

So what could cause a 5.50% yield? A better question is how will it be prevented.