Money is moving out of U.S.Treasuries in anticipation of higher interest rates

01/11/2010 12:17 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The bond market is putting distance between European and U.S. government bonds. Yields on U.S. 10-year Treasury have climbed twice as fast as yields on similar German government bonds since the start of December, according to Bloomberg. The bonds had traded in sync since April 2007.

The cause?

A belief that a faster growing U.S. economy will lead the Federal Reserve to raise interest rates well before the European Central Bank does. The consensus among economists is that the U.S. economy will grow by 2.6% in 2010 while the German economy grows by 1.9%.

You can see one reason for this conclusion if you look at unemployment rates for the two economies.

The U.S. economy lost just 85,000 jobs in December and official U.S. unemployment stayed steady at 10%. In December the official unemployment rate for the 16 euro economies climbed to 10% from 9.8%. The 10% rate is the highest in 11 years.

An increase in interest rates by the Federal Reserve would drive down the price of already-issued bonds until they yield the same as newly issued bonds do. Yields on 10-year U.S. Treasury notes have climbed (which means prices have tumbled) by 0.45 percentage points to 3.83% since December 4. The yield on comparable German bunds rose just 0.2 percentage points to 3.38% in that period.

JPMorgan Chase told Bloomberg that it expects that the yield on U.S. 10-year Treasuries will reach 4.1% by June 30 while the rate on German bunds falls to 3.35%

Since rising yields create loses for bond owners and falling yields generated profits, not surprisingly bond investors have been moving out of U.S. Treasuries and into European bonds such as German bunds. Last quarter U.S. Treasuries lost 1.32%, while German bunds returned 0.13%, according to Bank of America Merrill Lunch.

If the JPMorgan Chase projection of a 4.1% yield by June 30 is correct, Bloomberg calculates that a bond investor who sold Treasuries and bought bunds would earn a profit of about 2.1%.

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