Rising Bond Yields (or, The Magazine Cover Indicator Lives!)

10_year_tbill
Chart courtesy of stockcharts.com

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A few months ago, we noted (with an  "Uh-Oh") that Business Week’s February 19, 2007 cover story was on our "Low, Low, Low, Low-Rate World" (for more on the magazine cover indicator, see this).

So far, the timing is of the indicator has been rather typical: Rates ticked down, hitting their nadir (4.48%) a ~month after the cover story appeared. Its been nothing but up since then: Yield on the 10 year bond reversed course rather dramatically. From that sub 4.5% trough, the yield on the benchmark note is now at 4.94% — the high point for the year. The 10 year yield has not been over 5% since August 2006.

0708covdcHere is a quick overview as to why yields have moved up — and are likely to keep going higher:

1. Global Yields are higher:  The WSJ Marketbeat notes that there are "higher yields around the globe. Major central banks, such as the European Central Bank and the Bank of England, are in the process of adjusting their target rates higher, and that’s boosted the yields in other markets. The 10-year British gilt yielded 5.17% as of [5.22.07], while the 10-year German bund was yielding 4.36%, both highs for the year, and bonds in Canada and Australia were also at yearly highs. The U.S. long had higher yields than many other nations, which helped keep capital flocking to the country, but that advantage has faded."

2. Overseas Economies are RobustAhead of the Tape columnist Justin Lahart notes that "Overseas economies have remained strong despite the
U.S. slowdown. That has stoked inflation worries abroad, which in turn
is helping to push interest rates higher and keep pressure on central
banks."

3. Rate Cut expectations are dramatically lower: Fed Fund  futures are only forecasting a 50/50 chance of a reate cut by year’s end. As recently as  March, the Fund Futures were anticipating at least three 25 basis interest-rate cuts from the Federal Reserve.

4. Fed Fund rates could be going higher: Bloomberg noted that "Options on Federal Fund futures at the Chicago Board of
Trade indicate a 41 percent chance the central bank will lift its
target rate for overnight loans between banks to 5.5 percent from
the current 5.25 percent, according to data compiled by
Bloomberg. A month ago, they showed no expectations for an
increase."

5. Diversification Away From US Treasuries and Dollars: The Chinese are seeking ways to diversify their $1.2 trillion in foreign reserves; Middle Eastern Oil Countries are doing so also; Japan may soon follow. Most of these regions (Asia, Europe, Middle East) remain net purchasers of U.S. Treasurys, but at a somewhat slower rate. It doesn’t require heavy selling to push yields higer, merely slowing the purchases of our massive debt sends yields upwards.

6. Political Blowback: As the G8 summit takes place, we might as well admit the elephant in the room that too few people have acknowledged: The US ain’t very popular around the world these days.  Some countries have used that opening to move away from the dollar as the world’s reserve currency. Its a small smack at the US and its unpopular President. Of much greater concern than petty payback, it isn’t too hard to imagine some point in the future where Oil or even Gold is priced in Euros – THATS a situation with grave consequences. 

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Sources:

Five Reasons: Rising Bond Yields
David Gaffen
Marketeat May 23, 2007, 3:37 pm
http://blogs.wsj.com/marketbeat/2007/05/23/five-reasons-rising-bond-yields/

Look Overseas For Why Rates In U.S. Are Up
Justin Lahart
WSJ, June 5, 2007; Page C1
http://online.wsj.com/article/SB118100620692124512.html   

Fed Faces Pressure to Raise Rates, Options Show
Daniel Kruger 
Bloomberg, June 4
http://www.bloomberg.com/apps/news?pid=20601068&sid=az3bgEAXzcf8&

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