5.5% Plus Yields on 2010 Treasuries? No Way!

Includes: IEF, TBT
by: Kimball Corson
Morgan Stanley (NYSE:MS) thinks 10 year Treasury yields will rise about 40% to 5.5% in 2010, and, from that push, that 30 year Treasuries will go to 7.5%. I don’t believe that is correct, even if we had a roaring V shaped recovery. MS believes this because it thinks the US is going to face its deficits problem and GDP growth will be good.

I submit our government can face the deficits problem all it wants to, but the real question is what can it do about the deficits in short order. I submit, nothing much. On the GDP growth issue, 10% plus unemployment will cause the Fed to slow any rise in interest rates unless unemployment really improves. Given positive GDP growth, employment is the big question and will control what the Fed will let happen in regard to interest rates.

But there are issues to consider here. My earlier view that we would not see a rise in interest rates in 2010 was predicated on GDP growth in the range of 2% to 2.5%, with unemployment holding steady, if not worsening a bit in 2010. But now, better heads are calling for 3.5% to 4.4% 2010 GDP growth and that causes me to back away a little bit, but not by much.

What I see is the possibility of a spike in interest rates if we have a stronger than expected 4thQ 2009 or 1stQ 2010. But I don’t think any spike will hold. The Fed certainly won’t let go hastily. Also, if the stock market underwent a serious correction in 2010, which has some non-zero level of probability, and stockholders scrambled to the safety of Treasuries, that would check rising rates, too. Morgan Stanley’s guesstimates remain beyond the pale.

If unemployment remains above 10%, it is going to be quite difficult to get a sustainable and strong rise in consumer spending and, as a result, a truly strong increase in GDP growth. Absent such growth and big improvement in employment, the Fed is going to keep the clamps on interest rates for the foreseeable future. Monetary and fiscal authorities will do all they can, especially in an election year, to keep unemployment from rising still further and that includes holding interest rates down until employment improves significantly.

Employment is the key to interest rates and high GDP growth.

Disclosure: None relevant

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