Commentary

Is the worst over, or just beginning?

Falling long-term Treasury yields could eventually help consumers - but also may be a sign of continued concern about the economy.

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By Paul R. La Monica, CNNMoney.com editor at large

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The yield on the benchmark 10-year Treasury has plunged in the past few months and is getting close to the 45-year low hit in 2003.

NEW YORK (CNNMoney.com) -- Bond yields have plunged in the past few weeks. And even if you are not an active investor, you should care about what's been going on in the bond markets lately. Here's why.

The yield on the benchmark U.S. 10-year Treasury currently stands at about 3.33%, down from nearly 4% about a month ago. The rate on this long-term government note is a key factor behind what happens to fixed-rate mortgages.

If rates continue to fall, they could hit not only a new low for the year - the 10-year briefly touched 3.28% in January - but could come close to falling below the 3.07% level they hit in June 2003, which was a 45-year low at the time.

Other Treasury rates have also fallen sharply. The yield on the U.S. 2-year Treasury is now only 1.58%. The rates on these issues influence the rates for other types of consumer loans, as well as small business loans.

The fact that rates are this low is a sign of just how weak the economy is, since lower rates usually correspond with tougher economic stretches while rising rates are often a product of a robust economy.

Still, on the surface, falling longer-term yields should be a relief for consumers. The problem is that loan rates have not fallen as far as they should considering how much yields have declined because of the problems in the credit markets from the subprime mortgage meltdown.

"Fixed-rate mortgages are around 5.8%, substantially above a 3.3% 10-year note. What's happened is while Treasury yields are falling, private sector rates have not moved much. Mortgage brokers and consumers might be surprised rates aren't lower. But the mortgage market is gummed up," said Steve Van Order, chief fixed income strategist with Calvert Funds.

But Van Order thinks that some of the actions the Fed has taken in the past few months - including six interest rate cuts since September as well as the introduction of several loan facilities to provide much-needed cash to struggling banks - could eventually get banks to turn on the lending spigot again.

Several other bond experts agreed that there is some good news to be found, but that it will take time before banks are comfortable lending even to high-quality borrowers again.

"Treasury yields coming down are good for consumers," said Stephen Cooke, director of credit research SMH Capital Advisors, Inc, a firm that primarily invests in high-yield bonds. "And certainly in this environment, it makes borrowing more affordable for all sorts of things."

"However, in this credit crunch, companies still aren't lending," he added. "It will take a while for credit to loosen up and for low rates to flow through and help the economy."

There's another good sign that can be gleaned from the low yields. Despite all the doom and gloom forecasts about the U.S. economy, many foreign investors still find the Treasury market to be a safe haven. That's contributing to the drop in yields since bond prices and rates move in opposite directions - in other words, more buying leads to lower yields.

So at risk of sounding Pollyannish, it is encouraging to note that big central banks in Asia and Europe are not bailing on the U.S. economy. According to a report released by the Department of the Treasury on Monday, foreign central banks bought a net $36.1 billion in Treasury bonds and notes in January. That was a record.

And they did that even though the dollar had continued to weaken - which, in theory, should make Treasurys less attractive.

"Treasurys are backed by the full faith and credit of the U.S. government. And even with the dollar weakening, global markets are convinced, as well they should be, that they will be paid back," said John Canavan, an analyst with Stone & McCarthy, fixed income and economic research firm.

"There is a remarkable safety factor and even in troubled times, Treasurys remain the safest most liquid asset for many investors," Canavan added.

Van Order pointed out that another factor pushing Treasury prices up and yields down this week that could be good news for consumers. It seems some speculative investors may have been dumping oil, gold and other commodities whose prices have surged in recent weeks in order to purchase Treasurys.

The price of oil has dipped to about $102 after hitting a trading record of nearly $112 earlier in the week, while gold prices, which surged to above $1,000, fell back to $920 Thursday. If this trend continues, inflation concerns could diminish, which would make it a lot easier for the Fed to deal with the weakening economy since inflation would be less of a worry.

Of course, low rates have also hurt consumers. As I wrote earlier this week, there is a lot of frustration about the fact that the rates for savings accounts, money-market accounts and certificates of deposit (CDs) have fallen along with interest rates.

Still, it's undeniable that continued interest in the U.S. Treasury market from overseas investors - even with our economy in a funk - combined with signs of inflation pressure ebbing could mean that the markets and economy may not get much worse.

"There is a case to be made - cautiously - that the panic wave may have crested," Van Order said. "This doesn't mean the economy is out of the woods. But people I've been talking to are feeling a little more relieved and optimistic. It just feels better this week."

Issue #1 - America's Money: All this week at 12 pm ET, CNN explains how the weakening economy affects you. Full coverage.

Have you lost your job, your business or your home? Are you raiding retirement accounts to pay the bills? We want to hear from you. Tell us how you're being affected by the weakening economy and you could be profiled in an upcoming story. Send emails to realstories@cnnmoney.com. To top of page

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