Treasury Yields Are a Good Barometer of Economy's Future Prospects

The first chart gives you the historical context for Treasury yields, and the second chart focuses on the recent action. When the 10-yr Treasury hit 2% at the end of last year, that was a sign that the market was convinced that we were in for a huge depression and deflationary environment. The world was so desperate for the safety of T-bonds that yield was almost irrelevant.

Since then, the reality has been much better than expected. The simple fact that the economy has avoided a depression is probably enough to explain why stocks and Treasury bond yields are sharply higher. Yields are still relatively low from an historical perspective, however, and this is one reason why I have been saying that the market is still relatively pessimistic about the future. No one is ready to believe that we will have a normal recovery (Pimco's "new normal," which calls for a future of very disappointing growth, is all the rage these days). Everyone is worried about the deficit, about big and bigger government, and about higher taxes. Many worry that the Fed won't tighten, that inflation will be huge, and that the dollar will collapse. Others worry that the Fed will tighten, and that this will kill the economy. There is no shortage of things to worry about these days, and that is a good sign that the stock market is not yet in "bubble territory."

If Treasury yields move above 4%, then that would be a sign that the market was buying into the notion of a decent, but not spectacular, recovery. Higher yields would most likely go hand in hand with the beginnings of a Fed tightening, and the Fed is not going to tighten until they are confident the economy is recovering. If Treasury yields move back to 5%, that would be a sign that the economy was doing pretty well, and/or that inflation was expected to move higher.

In short, Treasury yields are a decent barometer for how optimistic the market is about the economy's future prospects. The higher they go, the better things will be.

Comments

[Moon Kil Woong:]

The 70's high Treasury yields were not signs of a positive time. Yields rise in response to a variety of factors including economic vigor, inflation, lack of trust in the government's out of control spending, and too much loose money in the market.

I think it is too soon to say if the rise in rates here is a repudiation of government spending and Federal Reserve's QE Zirp rate policies or a confirmation that the economy is once again back on track. If rates rise too quickly they can easily dampen any chance of a recovery. Thus it becomes very likely that the economy gets addicted to low rates and we gett Greenspan bubbles all over again but quite a bit worse (since Bernake easing is more likely to breed Hindenburg sized blimps).

Oct 27 06:37 AM

[chap08:]

I really doubt that Treasury yields forecast the economy in the same way that they used to. In particular, foreign governments / central banks now own so much of the Treasury market that it distorts the truth. They are not buying them as investments, they just need a deep market to park their dollars. Consequently their actions say nothing about the prospects for the economy. All it means is that foreign governments are prepared to take the risk of funding our deficit in order to keep their exports going.

Oct 27 07:05 AM

[Faisal Humayun:]

Treasury Yields can be subject to some level of manipulation through debt monetization by the Government...any thoughts or opinions on that?

I think its not always that treasury yields reflect the real picture...However, the treasury yields are surely showing that inflation is coming...and inflation might be coming in the future in a big way...yields have not gone down even after monetization...

Oct 27 07:44 AM

[jeremiah74:]

a. i join the above in saying that central bank buying, either in Asia to apr $ reserves or the Fed to push down the curve to make mortgages and corporate funding cheaper, are a big part of the picture

b. seasonally yields go up every summer and then go down into year end. we are still lower than same time last year

c. there are long term concerns on sovereign risk and sutainability.

so a+b+c are hardly a sign of good times to come, rather a sign of malaise

Oct 27 08:52 AM

[Plant the s...:]

I would chime in that central bank buying is also an investment in global trade, some of which trickle back to the US.

Nov 04 05:25 PM