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By Elliot Turner

Many have been talking about the rising yields in Treasuries since the Federal Reserve Bank embarked on QE2. As the story goes, Ben Bernanke’s QE2 initiative is failing already because it’s designed to keep yields low, yet yields have done nothing but rise since QE2 began. The story then goes on to assert that rising rates are a sign of concerns over the budget deficit. There are several wrong assumptions founded in short-termism in this view that can hurt investors today, a time when people should be digesting the bigger picture

First, it’s important to note that while the Fed’s stated goal is to achieve lower interest rates with QE2, the real goal is to shape expectations about inflation (check out my Mythbusters post for some more on the false assumptions in response to QE2). The Fed WANTS people to start expecting more inflation, as that will go a long way towards preventing a deflationary environment. Second, rising rates can happen for many reasons, only one of which is the expression of concern over the deficit. Rates also rise as the prospects for RECOVERY improve. Therefore, it’s not necessarily a bad thing to see rates starting to creep upwards, but it’s our job to figure out what the precise catalysts are.

Where Are Treasuries Today?

Today is but one point in time in reference to many others. People can make whatever assertion they want if they narrow the timeframe to meet their worldview. Therefore it’s important to try to focus on the bigger picture and not get caught up in the minutiae.

Let’s look at the chart to see what’s really going on in Treasury (NYSEARCA:TLT) markets:

Key levels on TLT

(Click to enlarge)

On this chart I’ve added four points of reference that deserve attention–two lines and two circles. The lowest horizontal line on the chart represents the point at which yields were at their highest for this year (remember in bonds, lower principal=higher yields and vice versa). Above that level is a horizontal line which marks where Treasuries were at this time last year. The circle in late August marks the date when Ben Bernanke issued the renowned Jackson Hole speech in which he indicated that the Fed will embark on another round of quantitative easing. Lastly, the next circle marks the date in which the Fed formally announced QE2.

Recovery vs. Flight to Safety vs. Deficit Concern?

These points of reference are important in sifting through the fact and fiction in the debate over rising Treasury yields today. Looking at this one year chart we can clearly see that despite the Fed maintaining interest rates at the 0% level, longer term Treasuries have made some significant moves. That being said, interest rates have consistently stayed LOWER during 2010 than they were last year at this time. April of this year, as the stock market was making its highs saw Treasury yields hit their lowest levels. That was also when feelings of recovery were riding highest.

When the European sovereign debt worries climaxed in early May with Greece’s troubles is exactly when rates plunged lower in the US. Why is that? Treasuries are one of the most liquid markets in the world and people are so confident that the US won’t default, that in a world of concern, the United States Treasury market remains the “flight to safety” of choice.

At the time of the Jackson Hole speech marked the first point at which the exceptionally low yields started to slowly rise. Yes this deserves repeating. From the moment Ben Bernanke announced his willingness to use another round of QE, rates started rising, not falling. Why? Well the answer is twofold. First, Treasury rates were already exceptionally low as a direct result of the economic uncertainty and alarm around us. Second, when Bernanke announced QE2 he helped ease a lot of that uncertainty and concern and people began reallocating capital from Treasury markets (where money was stored for safety) and back towards riskier investments like equities (where money is allocated to generate a return on capital).

Yields on the Rise

Factually speaking, Treasury yields are rising today. However, the fact that they are rising alone matter very little outside of the bigger picture context.

The urgency in the talk about rising Treasury yields is borne in short-termism and ideology, not in market-based fact. With the political stakes rather high regarding the high jobless rate, deficits and tax cuts, it’s far too easy to get lost in political rhetoric while missing important empirical evidence. What we have, contrary to the publicly stated myth, is a situation in which yields started rising, but they did so from suppressed levels.

It would be one thing if rates had flown from already elevated levels, but a different story altogether for them to start rising from semi-crisis levels. This is a good thing! The Treasury market is sending us a message here, and that message is that things in the broader economy are in fact improving.

Disclosure: No positions

Source: What’s Going on With Rising Treasury Yields Today?