The yield on the 10-year Treasury bond hit 3.00 percent on Thursday, a level not seen since July 27, 2011, up from 2.78 percent on the previous Friday.
The discussion surrounding this move had to do with the fact that the Federal Reserve will probably begin to reduce the amount of Treasury securities and mortgage-backed securities it has been buying every month in the recent round of quantitative easing. On Friday the rate dropped off slightly to 2.93 percent as the figures on employment for August did not come in as expected.
However, let me put these moves in perspective.
The yield on the Treasury's inflation protected bonds with a ten-year maturity rose to 0.90 basis points on Thursday, the highest level it has traded at since the spring of 2011. On July 27, 2011 the yield on these 10-year TIPS was about 0.56 percent. In early August 2011, the yield on TIPS dropped below zero for the first time ever and, beginning later that summer, dropped below zero again and remained there until earlier this year.
I have argued that this drop in the yield on TIPS coincided with the flow of "risk-averse" money out of Europe, especially the fiscally challenged countries, and into the safe-havens like the United States…and Germany. (See my post from August 22, 2013.)
To show that this movement in funds was more than just a United States…or Federal Reserve…"thing" I submit information on the 10-year German bund.
The yields on the 10-year Treasury issue and on the 10-year German bund have moved almost in parallel during this time period.
The yield on the 10-year German bund averaged around 2.25 percent in the third quarter of 2011. In the fourth quarter it averaged around 1.90. Since then, the yield has dropped below 1.20 percent.
In May 2013 the yield on the 10-year German bund begin rising along with the increase in the yield on the 10-year TIPS and the 10-year Treasury note. On Thursday, the very day that the 10-year US Treasury issue topped 3.00 percent, the comparable German security topped 2.00 percent, the first time it had done this since July 2011.
A coincidence? I don't think so. Not with three years of data to support the parallel movement of the three yields!
Analysts argued that the yield on the 10-year German bund dropped back below 2.00 percent on Friday because of the softness in the German industrial production figure that was reduced that day. This report then was followed by the smaller than expected increase in employment in the United States.
The important thing to me is that there is more going on in the world than just the possibility that the Federal Reserve is going to taper its purchases of securities.
As far as the short-term end of the market, which is more closely impacted by Federal Reserve actions, there seemed to be very little pressure for the effective federal funds rate to rise as it averaged around 8 basis points for the week.
Some market pressures seemed to be exhibited in the futures market, however, as the December federal funds futures "implied a fed funds rate of 0.45 percent…up markedly from 0.18 percent on May 1 and 0.31 percent on August 1…." (From the Wall Street Journal article.)
Longer-dated contracts contain even higher implied rates for the future. For June 2015 the implied federal funds rate was 0.87 percent and for August 2016, the longest dated contract, the implied rate was 2.17 percent.
The market may be reflecting some anxiety over the future leader of the Federal Reserve and this feeling is being reflected in what the market believes will happen to short-term interest rates. For example, Zach Pandl, senior interest rate strategist at Columbia Management is quoted as saying, "Markets realize that you have a lame duck Fed chairman, and forward guidance, so important for anchoring short-term rates, was put in place by Ben Bernanke and Janet Yellen, who look like being succeeded by someone from outside who may have a different view of their commitment to keeping rates low."
The thing is that for now, the yield on the 10-year Treasury security may be reaching a short-term resistance level. The yield on this security reached a historical low of around 1.60 percent in early May, so the rise to 3.00 percent over the last four months has been spectacular. But, it may be time for some reflection. And, some traders have stated that 3.00 percent may be the level for them to re-invest some of the funds that they earlier withdrew from the bond markets.
I still believe that longer-term bond rates will go higher over the next year. For one, I believe that the yield on the 10-year TIPS should, as an intermediate-term move, go closer to 1.50 percent from the level it closed at on Friday of 0.84 percent.
If inflationary expectations remain a little above 2.00 percent, where they have stayed for the last three or four months, then the yield on the 10-year Treasury could rise to 3.50 percent or above. And, I believe that this will happen as the psychology of the market changes with the appointment of the new Chairperson of the Federal Reserve and with whatever amount of tapering of Federal Reserve purchases that takes place.
Longer-term, I still believe that the longer-term Treasury yield should be around 4.00 percent.