Higher Bond Yields: Are We Making Progress?

Includes: AA, BA, BAC, C, EMKR, GE, NI, TBT, TIP, TLT
by: Dirk McCoy

A few months ago, I penned an article entitled Let's Just Say It, Print More Money. Some misunderstood me to be touting Keynesian stimulus, which couldn't be further from the truth. Rather, I was looking for an increased money supply to counter deflationary forces by raising the specter of inflation- and not only put a floor on stocks and other assets, but provide a stimulative effect.

For all the talk of Bernanke "printing money", the truth is that most of the money "printed" thus far has been fully sterilized- if you consider Treasuries to be high quality. Given the vast natural resources and manpower of the US and the government's power of taxation, it would be a very aggressive bet to assume default by the US government on its debt instruments. Nothing short of global Armageddon or bio-disaster will keep the US from fulfilling (or at least rolling over) these obligations. Not that we needed Moody's to confirm this by reaffirming a AAA rating.

However, the yield on 10 year Treasuries is ready to eclipse 4%, and an auction of 30 year Treasuries today will shed more light on the situation. But even if yields continue to climb, this is not necessarily a bad thing- yields have been significantly higher during better times. And higher long term rates are not necessarily bad for the market, or the economy- as long as short term rates stay reasonably low.

First, while long term market rates are climbing back towards levels when the economy and markets were both doing better, short term rates are still very low. This adds up to a steep yield curve - good for bank profits. Second, this higher rate will serve to bolster demand for US debt, while at the same time providing impetus for Americans to consider the cost of government overspending. It was said that Ronald Reagan loved large deficits because it changed the nature of the debate in Washington from government spending to government saving. Perhaps higher long term rates will do the same now.

But most importantly, higher bond prices foretell inflationary forces. This is a good thing, because by avoiding the prospect of continued asset value declines, potential investors and buyers can have more confidence that there will be buyers in the future. Accurate price signals in oil and foreign goods can drive purchases of alternatives economically, instead of via artificial central planning. And pressures on semi-fixed cost items, such as union salaries and debt service, can be alleviated.

Meanwhile, excess labor, technology (higher efficiency aircraft, CPV solar, smart grid), and commodities (milk, aluminum, and natural gas for sure) await increasing global demand, ready to mitigate inflation. To the extent that government policies are focused on increasing output instead of subsidizing non-competitiveness, the long term prospects for the US (and global) economy - and stock market- are bright. Higher long term interest rates may help more than they hurt in that regard.

Disclosure: No positions