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Friday, March 26, 2010 4:20 AM


Treasury Yields Rise; What's Cooking?


Long term treasury yields are on the verge of breaking out. In the March 25 issue of Breakfast with Dave, Rosenberg mentions various factors in play.

Despite signs of economic cooling in Q1 (around 2.5% growth and half the Q4 pace) and lower inflation expectations, the 10-year Treasury note yield is ratcheting up (in a destabilizing fashion) and devoid of any bearish economic data (for a range of technical/fund flow reasons as was the case in the summer of 2007).

In technical lingo, it does look as though the yield is breaking out from a triangle since the December 31, 2009 yield peak —go back to that period in December and January, 3.85% on the 10-year Treasury-note served at least three times to be major technical support — a break of that this time around would mean some serious near-term trouble (the nearby high closing level was 3.98% back on June 10, 2009).

Rates may be rising because:

  • Of added supply concerns from Obamacare;
  • Sovereign credit quality;
  • Heightened fears over a looming trade spat with China (if the Treasury accuses China of being a ‘currency manipulator’ next month);
  • Hedging related to the most recent huge wave of corporate bond issuance;
  • Swap rates have also become unhinged (they traded at an unprecedented 8bp discount to 10-year Treasuries yesterday) ….

… but yields are NOT rising from inflation (in fact deflation signs are re-appearing again). Hence, real yields are on the rise ... not typically what an equity bull would like to see with real growth now softening. Rising real rates as real growth slows means it is time to get more defensive, not more cyclical (especially with small-cap stocks up nearly 10% year-to-date, doubling the performance of the large-caps. This will not be sustained as the global and domestic economies cool off through the balance of the year.)

Bottom line: Stronger U.S. dollar. Rising bond yields. Lower commodity prices. Slower growth. And the stock market is flirting at post-crisis highs. Bond yields are rising temporarily and this will very likely prove to be a good buying opportunity; however, over the near-term, higher yield activity may well persist and the question is how the equity market is going to handle this backup in market rates. Recall that the 10-year yield had a March to June 2007 spike of 90bps before the rate and credit collapse took hold in the back half of 2007! Could it be that history is rhyming again? The March-June period has been seasonally weak for the Treasury market in five of the past six years.
I concur with Rosenberg this is not an inflation related phenomenon. And with the economy slowing, fundamentally treasury yields ought to be dropping.

Then again most do not believe the economy is slowing. However, new home sales hit fresh record lows, state tax revenues that have collapsed, and the Chicago Fed National Activity Index dropped to –0.64 in February, down from –0.04 in January.

Bear in mind that new home sales typically lead every recovery. I am hard pressed to believe it's different this time.

Weekly claims were better than expected, but 442,000 new claims is not exactly an economy that is humming along.

Whatever the reason, most likely a combination of the 5 bullet points above plus seasonality, rates can easily run here. If they do, and the stock market breaks lower, 2010 might be the year where there are no hiding places at all except in the much despised US Dollar.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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