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The rout in the Treasury market continues: Yields on the 10-year note close at 2.38%, up from just 2% a little more than a week ago
03/19/2012 6:22 pm EST
On March 16, the day of the inflation announcement ,10-year U.S. Treasury notes fell taking the yield to 2.31% at noon New York time. That was a huge change from Monday, March 12, when the benchmark U.S. 10-year Treasury yielded just 2%.
This week hasn’t begun any better. The 10-year Treasury note fell in price (which means they climbed in yield) for the ninth straight day. The yield on the 10-year Treasury rose to close at 2.38%, the highest yield since October 28, 2011.
Last week’s inflation numbers reminded bond buyers that at 2% or even 2.3%, 10-year Treasuries are losing ground to inflation. That may have been a deal bond buyers were willing to take during the worst of the Greek debt crisis. But now that the crisis has moved off the front burner—for the moment—sacrificing yield for safety no longer seems quite so compelling.
In normal times—remember those?—the yield on the 10-year bond is typically 1 percentage point over inflation. That says the bond should be yielding 3.9% or so.
The move from a yield of 2% to one of 2.38% in a little more than a week has got the bond market concerned. Big money managers have purchased Treasuries over the last few months on the strength of the Federal Reserve’s promise to keep short-term rates at current extraordinarily low levels of 0% to 0.25% through the end of 2014. But the move up in long-term yields and down in long-term prices in the last week has cost these buyers of 10-year Treasuries about 13% of the value of their bonds. A rise in yields to 3.9% and the resulting drop in price would bring the loss to 40%.
In reality, though, bond yields won’t reach 3.9% and losses won’t reach 40% because an increase in interest rates of that dimension would be enough to stop the U.S. economy dead in its tracks as mortgage rates soared and borrowing got more expensive in general for consumers and companies.
Rising rates and a slowing economy would also be enough to kill off the rally in U.S. stocks.
And that would be enough to bring buyers looking for safety back to bonds, raising prices and lowering yields.
The question right now is whether or not the Federal Reserve will let the financial markets work out a new equilibrium on their own—with slower growth and lower stock prices putting an end to the drop in bond prices and the rise in yields. Letting financial “nature” run its course would put the still fragile economic recovery at risk, and the betting is that the Fed wouldn’t be willing to risk that.
Rising yields on 10-year Treasuries, in other words, put some form of quantitative easing back on the table.
Which turns the question from Whether? to When?
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