by, David Frank
On Monday, President Obama announced a framework for a bipartisan agreement over the Bush era tax cuts. As he stated in a press interview, “I’m not willing to let our economy slip backwards just as we’re pulling ourselves out of this devastating recession, I’m not willing to see two million Americans, who stand to lose their unemployment insurance at the end of this month… it would be the wrong thing to do.”
Not only is this decision causing a rift between senate democrats and the Obama White House, but this decision is having a measured effect on bond yields. Obama is now feeling the wrath of rogue bond investors. These investors are concerned that this move to extend tax cuts will increase the federal deficit to record levels. We are seeing bond traders now making an impact and, it is no coincidence between this recent backup in bond yields and concerns that the Obama Administration finds it all too easy to increase the deficit by extending the tax cuts and adding other tax incentives to those who do not need them, the millionaires and billionaires.
However, this will not have a huge impact, in medium or long term deficit problems. Currently the US, the federal deficit is totaling $1.3 trillion in the fiscal year that ended Sept. 30, according to the Congressional Budget Office. Further projections show the federal deficit this year will exceed $1.5 trillion, or 10.6 percent of gross domestic product; a dangerous trend.
After Obama announced on Dec. 6 that he will accept a deal that would extend current tax rates for high net worth taxpayers for another two years in exchange for extending federal unemployment insurance for the long term jobless insurance and cutting the payroll tax by $120 billion for one year, we saw yields on the benchmark 10 year Treasury Notes soaring to the biggest multi-day rise in two years as investors dumped bonds in the open market.
By doing this, investors are showing they do not like current fiscal policy and by doing, they will drive up government borrowing costs. We can estimate that yields on 10-year notes will rise by about 1 percentage point to 4 or 4.5 percent based on current US growth. Obama cannot afford this war with bond investors. Bond investors hold the power to shut the bond markets down and not finance anything until the administration curbs its enthusiasm towards reckless fiscal policy.
While Obama must be commended for playing bipartisan politics, he must find a way not to anger investors who can shut the bond markets down by dumping bonds into the open market causing yields to soar. Such an action will only lead to increase costs for the government and making it even harder to raise capital needed to spur an already sluggish economy. On Friday, the 10 Year Treasury fell 5 basis points to 3.23 after yields rose 35 basis points over the past two days in the biggest two day price slump since Sept. 19, 2008, when the markets were in turmoil following the collapse of Lehman Brothers Holdings Inc.
*Quote from Reuters.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.