Rising Bond Yields (or, The Magazine Cover Indicator Lives!)

A few months ago, we noted (with an  "Uh-Oh") that Business Week's February 19, 2007 cover story was on our "Low, Low, Low, Low-Rate World" (for more on the magazine cover indicator, see this).

click to enlarge

Chart courtesy of stockcharts.com

So far, the timing of the indicator has been rather typical: Rates ticked down, hitting their nadir (4.48%) a ~month after the cover story appeared. It's been nothing but up since then: Yield on the 10 year bond reversed course rather dramatically. From that sub 4.5% trough, the yield on the benchmark note is now at 4.94% -- the high point for the year. The 10 year yield has not been over 5% since August 2006.

Here is a quick overview as to why yields have moved up -- and are likely to keep going higher:

1. Global Yields are higher:  The WSJ Marketbeat notes that there are "higher yields around the globe. Major central banks, such as the European Central Bank and the Bank of England, are in the process of adjusting their target rates higher, and that’s boosted the yields in other markets. The 10-year British gilt yielded 5.17% as of [5.22.07], while the 10-year German bund was yielding 4.36%, both highs for the year, and bonds in Canada and Australia were also at yearly highs. The U.S. long had higher yields than many other nations, which helped keep capital flocking to the country, but that advantage has faded."

2. Overseas Economies are Robust:  Ahead of the Tape columnist Justin Lahart notes that "Overseas economies have remained strong despite the U.S. slowdown. That has stoked inflation worries abroad, which in turn
is helping to push interest rates higher and keep pressure on central banks."

3. Rate Cut expectations are dramatically lower: Fed Fund  futures are only forecasting a 50/50 chance of a rate cut by year's end. As recently as  March, the Fund Futures were anticipating at least three 25 basis interest-rate cuts from the Federal Reserve.

4. Fed Fund rates could be going higher: Bloomberg noted that "Options on Federal Fund futures at the Chicago Board of Trade indicate a 41 percent chance the central bank will lift its target rate for overnight loans between banks to 5.5 percent from the current 5.25 percent, according to data compiled by Bloomberg. A month ago, they showed no expectations for an increase."

5. Diversification Away From U.S. Treasuries and Dollars: The Chinese are seeking ways to diversify their $1.2 trillion in foreign reserves; Middle Eastern Oil Countries are doing so also; Japan may soon follow. Most of these regions (Asia, Europe, Middle East) remain net purchasers of U.S. Treasury's, but at a somewhat slower rate. It doesn't require heavy selling to push yields higher, merely slowing the purchases of our massive debt sends yields upwards.

6. Political Blowback: As the G8 summit takes place, we might as well admit the elephant in the room that too few people have acknowledged: The U.S. ain't very popular around the world these days.  Some countries have used that opening to move away from the dollar as the world's reserve currency. It's a small smack at the U.S. and its unpopular President. Of much greater concern than petty payback, it isn't too hard to imagine some point in the future where Oil or even Gold is priced in Euros - THAT'S a situation with grave consequences. 

>

Sources:
Five Reasons: Rising Bond Yields
David Gaffen
Marketeat May 23, 2007, 3:37 pm
http://blogs.wsj.com/marketbeat/2007/05/23/five-reasons-rising-bond-yields/

Look Overseas For Why Rates In U.S. Are Up
Justin Lahart
WSJ, June 5, 2007; Page C1
http://online.wsj.com/article/SB118100620692124512.html   

Fed Faces Pressure to Raise Rates, Options Show
Daniel Kruger 
Bloomberg, June 4
http://www.bloomberg.com/apps/news?pid=20601068&sid=az3bgEAXzcf8&

Comments

[Johnny Bitc...:]

Barry - Looks like more casual chit chat with little basis.

The cover story indicator bla, bla, bla is laughable on these grounds:

a. the ten year yield hit its lows in Q2 2003 and has been in a gentle uptrend since

b. you reference a cover story about low, low rates in February 2007 - 4 years later in the gentle uptrend and 100 to 150 basis points higher - is supposed to have some kind contrary indicator meaning ? ridiculous.

c. one also wonders how you chose your chart timeframe which avoids the proper context of the multi-year rising rate trend. Do you just make stuff up and then tailor a loose presentation intended to support your delusions ?

d. nice try but that cover story's meaninglessness is only eclipsed in meaningnessless by your reference to it as some kind of contrary indicator.

Can you really support this statement of yours: "It doesn't require heavy selling to push yields higher, merely slowing the purchases of our massive debt sends yields upwards."

This seems like one of those smart sounding statements that basically says nothing. Not that there is anything wrong with that, but couldn't you just say nothing instead of saying something that says nothing ?

And gimme a break on the "the US isn't popular" causing policy shifts at worldwide central banks and sovereign governments. Isn't this just unsupportable junk economic chit chat ?

Do you really think policies are driven by an unpopular President and war ? doesn't seem plausible, but heck if it gets people to go to your website and you can sell some ads........keep on chit chattin'.

Oh.....and since you are so prescient, instead of just throwing out the "grave consequences"-i-am-try... statement, would you mind detailing those grave consequences.

After all, Barry, if you are trying to add value (and not just fishing for suckers to pay you 1% of their wealth each year), wouldn't you think identifying the "grave consequences" might be part of the point of you having an opinion about things ?

regards,

John

In the end,

2007 Jun 06 02:41 AM

[wixeywaxy:]

Your nemesis John is really reaching for it, in trying to puch holes in your remarks. He strikes me as an attention getter without a lot of substance. Obviously a nuerotic who enjoys insulting you with nothing to offer himself. Challenging you on the observation that the chinese could cause rates to go up simply by buying less of our treasury debt displays ignorance. Certainly they could produce an immediate effect by doing that as common sense would tell you. The chinese are going to protect their access to our markets which could be limited if they really seriously quit recycling their trade dollars into our treasuries, but since we are such voracous borrowers any reluctance backed by action however small would be reflected in rates. Vic

2007 Jun 06 10:32 AM

[Johnny Bitc...:]

vic - i am just as happy to be your nemesis when you say silly, unsupportable things.

the idea that lower demand could result in higher yields is not rocket science or interesting. the problem i have with it is that it appears to be a reach by Barry to identify a well known and longstanding phenomena and create some kind of story out of it.

yes, it could theoretically contribute to rising rates.

unfortunately rates could also fall in the midst of reduced Chinese demand.....based on either greater demand elsewhere or depending on which theory of the yield curve you happen to believe (pure expectations, preferred habitat, etc.).

One can also say "It doesn't require heavy BUYING to push yields lower, merely accelerating the purchases of our massive debt sends yields upwards". So what ? Who cares.

And, of course, rates can stay flat in the midst of Chinese buying or selling. Again, so what ?

The issue I have with alot of Barry's chit-chat is that it seems so purposeless (except to perhaps drive traffic to his website or build a brand for himself).

It seems like an assortment of observations about well-known phenomena surrounded by smart sounding statement which seldom take clear positions, with the possible exception of identifying longstanding phenomena and pretending he's making predictions.......inst... they are just observations.

Refer to his prediction of "rates are likely to keep going higher":

the fact is that rates have been trending up since 2003, which was the bottom of the Fed's tech bubble repair program.

so Barry is predicting higher rates based on a list of 6 things that sound really, really smart.

in reality, rather than i-am-trying-to-sound-s... land, this is how i look at it:

1. rates were pushed down dramatically by the Fed at a time when the Asian economies were doing quite well and recycled much of their dollar reserves into U.S. debt.

2. the economy came back reasonably well, the Asian economies continued to do well, and U.S. inflation began to increase gently at first but more noticeably lately. in response, the Fed has reversed its accomodation rates and has transitioned slowly to fighting inflation. this causes economies to slow, or at least their rate of increase to slow.

3. If you are following along and can deal with simple concepts, we can break it down now into:

a. slowing U.S. economy
b. rising inflation

4. Guess what happens when the U.S. economy slows and inflation rises ?

a. U.S. assets including Treasury bonds become less attractive and buyers, including the Chinese, demand a higher yield to compensate for the inflation (real vs. nominal return)

b. There may also be very good reasons for the Asian countries to diversify their assets independent of demanding higher yields, but let's leave that alone. See Modern Portfolio Theory or How to Avoid Concentration of Risk articles for further information.

Now, the bottom line on it all is that the important variable to follow is real rates and not nominal rates. Nominal rates are trending up and so is inflation. If the uptrend is one for one with inflation expectations, rates really haven't even changed in a real sense and that's what's important.

So, let's really bottom line it for simplicity purposes:

1. Treasury bond yields are rising. And have been for 4 years.
2. Inflation is rising.
3. Real bond yields are probably and the nominal rise reflects the inflation expectations premium.

The threat of Asian countries scaling back debt purchases or world commodities pricing shifting to Euros sounds scary and all, but it just pollutes the discussion of the rate situation.

Yeah, yeah, bla, bla, bla......I am really afraid of the Chinese and Barry's "grave consequences" b.s. about the new Euro standard he is predicting or chattering about or whatever he is doing.

Just like I was afraid the Japs were taking over the world when they bought Rockefeller Center and half of Hawaii ! And then subsequently lost their asses on the overpriced assets.

Now the Chinese own overpriced U.S. Treasuries. So what ?

john.

2007 Jun 06 11:52 AM

[Johnny Bitc...:]

Here's the bottom line on Ritholtz...presentatio... about magazine indicators:

The referenced story occurred 4 years into a rate uptrend - completely random or irrelevant.

Ritholtz provides a selected time period which shows rates higher than when the cover story came out - a longer time period provides better context to show that this cover story is 4 years late and not a good candidate for some kind of grand "cover story contrary indicator" theory.

Implied in Ritholtz presentation is that the cover story coincides with some kind of dramatic low - silly. ignore Ritholtz chart and just pull up the 5 year trend on the ten year. It is impressive that Ritholtz can put graphics identifying "cover story" on his charts but the key points make no sense whatsoever.

[INAPPROPRIATE TEXT REMOVED BY SA EDITORS]

john.

2007 Jun 06 02:20 PM

[User 1:]

John et all,

Please remember the ground rules of commenting on Seeking Alpha: dispute points, claims and arguments, but <b>please don't launch personal attacks on authors or other commenters</b> even if you strongly disagree with them. Why?

Because doing so doesn't further the debate, and it drags down the tone of the discussion on SA to the detriment of everyone.

2007 Jun 06 05:55 PM