Rising US Bond Yields
So what gives here.
The extra yield Treasury investors demand to hold 10-year notes over 2-year securities touched the widest since February on speculation an extension of tax cuts will spur growth and increase deficits. The benchmark 10-year yield rose this week to the highest level in seven months as retail sales advanced in November more than economists forecast and the Federal Reserve said the recovery is continuing. The U.S. economy grew at a faster pace in the third quarter, a report is forecast to show next week.
How investors perceive and interpret this will determine great many things; is it a reflection of higher growth in the future and thus a sooner than expected normalisation by the Fed. Or is it a result of supply concerns and the continuing double digit budget deficit by the Fed and thus the bond vigilantes attempt to go for the biggest prey in the park.
Now, to be fair I am stealing this argument from the latest G&F from CLSA penned by the always excellent Chris Wood. Here is what he says.
This raises the question of whether this rise in bond yields has been driven by growing optimism on the US economy or growing supply concerns. Note that the fiscal deficit in the US is now estimated to be about 9.5% of GDP in FY11 ending 30 September 2011, compared with 8.9% in FY10 and a recent high of 10% reached in FY09. GREED & fear’s view is that the answer to that question is a bit of both. Still it is also worth pointing out that the rise in government bond yields, like so much else, has been correlated globally. Thus, German bund yields have picked up by an almost commensurate amount as have Treasuries. The 10-year German bund yield has risen by 91bps to 3.03% since bottoming at the end of August. Again this market move could be influenced by a growing conviction about improving growth dynamics. Or it could reflect the reality that any move towards fiscal union in Euroland is going to cost the German taxpayer a lot of money.
Now, Chris Wood comes in favor of a neither one or the other explanation, but I would submit that the ultimate way investors choose to interpret rising yields in the US will matter a lot for general volatility and dynamics going into 2011. Indeed, this may all be a blip, but I believe that since the US has now effectively "postponed" any attempts to reign in public finances until 2011, US bond yields may turn out to be a recurring theme in 2011. Long bond trend followers, beware! (Although I agree with G&F that this is not the end of the long bull market in US bonds, the Fed is still here).