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Financial markets punish dollar and not Treasuries--so far
04/12/2011 2:34 pm EST
Can’t be that overseas investors found last week’s near shutdown of the U.S. government a reassuring sign of Washington’s fiscal responsibility.
Yields on U.S. bonds are lower now than when the government was running a budget surplus a decade ago—and when the amount of U.S. government debt outstanding was much, much lower. Marketable debt outstanding has climbed to $9.13 trillion from $4.34 trillion in the middle of 2007.
But the yield on the benchmark 10-year Treasury is just 3.49% as I post this on April 12. The average yield from 1998 through 2001, according to Bloomberg, was 5.48%.
And overseas investors aren’t fleeing the U.S. Treasury market. Foreign central banks bought 60% of the $66 billion in 10-year notes sold this year, up from 42% in 2010, according to the U.S. Treasury. Foreign investors as a whole owned $4.45 trillion in Treasuries as of January 2011, up from $3.7 trillion in January 2010.
The market certainly doesn’t seem to be worried about the chances of a U.S. default. Credit-default swaps on U.S. Treasuries—a kind of insurance against a bond issuer defaulting—stand at 0.415 percentage points. That’s a drop from the 2011 high of 0.515 on January 27.
I can think of two explanations for this—and, no, neither of them depends on overseas investors thinking U.S. politicians are any better at economics than they actually are.
First, the extremely low U.S. interest rates are a bet on a slowing of the U.S. economy and the postponement of the day that inflation climbs high enough to force the Federal Reserve to raise interest rates. Inflation in the United States—or at least inflation the way the Federal Reserve counts it—isn’t high enough now to push the Fed into raising interest rates before the very end of 2011 or, more likely, 2012. And if, as it now seems, the Federal Reserve is worried about the likelihood that spending cuts at the Federal and state levels will cut into economic growth, bond investors don’t have to worry about any early end to the Fed’s program of quantitative easing and any significant tightening of the money supply.
In other words, low U.S. interest rates have more to do with slow economic growth and the low likelihood of Federal Reserve tightening or interest rate increases than they do with faith that sound fiscal policies will emerge from Washington.
Second, financial markets are punishing the U.S. dollar instead of Treasury bonds. The Dollar Index, which tracks the value of the dollar against a basket of six currencies, dropped to 74.73 earlier today. That’s barely above the two-year low of 74.17 from November 2009. That low is the last significant support above the all-time low at 70.69 from March 8, 2008.
Think about this: The euro with all its problems has rallied back against the dollar to the 1.45 level for the first time since January 2010. The yen is flat against the dollar this morning even as the Japanese government raised the danger level at the Fukushima reactors to Chernobyl levels.
It might not seem especially logical that the bond and dollar markets should be giving such different reads on investor attitudes toward U.S. debt and fiscal policy. But the currency and bond markets operate with different lags—it’s easier to change a currency bet for or against the dollar than it is to reallocate a bond portfolio. Bond investors would prefer not to believe the worst about U.S. fiscal policy until they must. Figuring out where else to put the $4.5 trillion in U.S. Treasuries owned by overseas investors presents quite a headache, especially because there are, as of yet, no good government bond alternatives.
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