With the big-time reversal in bonds recently, investors are beginning to wonder whether the run is finally done.
Treasurys have rallied hard over the past three years, pushing the yield on the 10-year note from 6.79 percent in early 2000 to a 45-year low of 3.11 percent just a couple of weeks ago. Now that yield has kicked on up to 3.47 percent. By many lights that's still ridiculously low, a rate that implies the U.S. economy is going to be bogged down for a damn long time. Some have even professed the Treasury market a bubble.
The Fed, which has been at pains to maneuver long-term rates lower, would prefer that you not think such thoughts. With good reason, it turns out. As Treasurys shifted lower this year, so too have corporate bond yields and mortgage rates.
These lower borrowing costs have had a profound effect on the economy. There has been a surge in corporate debt issuance, most notably the $16.5 billion in bonds General Motors' is putting out to help shore up its ailing pension plan. New mortgage and mortgage refinancing activity have touched record highs.
If bond yields start heading significantly higher, all that manna goes away. Companies can't tap the debt markets to fix their balance sheets anymore, which means they have to syphon off money that might othewise be spent on hiring workers or buying equipment. Housing, one of the few things the economy has had going for it, runs into trouble.
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In their continuing effort to influence investor sentiment, Alan Greenspan and his team at the Federal Reserve -- Robert Parry excepted -- unintentionally did their best Wednesday to ensure that the glory days of low interest rates are a thing of the past.
There's one caveat, of course: If the economy sinks again, interest rates will surely sink as well -- great news for Treasury bond investors, maybe, but a disaster for the broader economy, and certainly nothing for which the Fed would want to take credit.
A worsening economy would eventually fuel deflation, and low interest rates wouldn't mean much. In that scenario, the Fed would be powerless to help, as it admitted Wednesday.
In effect, the Fed showed it was running out of ammo by cutting a smaller-than-expected quarter-percentage point -- hanging on for dear life to the last quarter-point cut in its "arsenal" -- and by telling the Wall Street Journal that its earlier talk about "unconventional warfare" (buying long-term Treasurys, mostly) was about as believable as a "triple guarantee" from the Iraqi Information Minister.
So the Fed has taken itself out of the game -- with one exception, which I'll mention in a minute -- leaving bond traders to rely mostly on their outlook for the economy when setting bond yields. If that's so, then yields are probably going higher.
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