Treasury Yields Define Future Economy
To any clear thinking outsider, equity market fluctuations make little rational sense.
For example, the Dow today has a pretty good little rally going. But it is displayed under the banner headline titled, “Stocks Rally after weak GDP“
That makes no logical sense at all. We find out today that our already fragile economy is having an even weaker recovery than previously thought… and… the Dow jumps +150 points! Huh?
Watching equity markets isn’t where prognosticators should look to read the tea leaves. With heavily manipulated Fed monetary policy, the place to watch like a hawk is U.S. Treasury Rates.
Yields are the highest in 2 years. Where U.S. Treasury bonds go, so goes the local and global economy.
Trends in Treasury Bonds
Ever since rumors started circulating that the Fed was considering ending its QE bond purchase program, bond yields have started heading upward. Since May 2nd the 10-year yield has risen +0.84%. It has jumped +0.5% just since June 6th and showing no sign of slowing down.
That is bad news for Ben Bernanke and The Fed. The whole purpose of Fed policy is to hold inflation to 2% until the economy recovers. It ain’t that good yet and 10-years are up to 2.6%.
Inflation is the last thing The Fed wants; especially if it is an unintended, artificial consequence of its own monetary policy.
Implications of Treasury Yields
Yields are the interest rates paid by the federal government to bond holders. The higher the yields, the more it costs to issue them. That is a primary driver of inflation.
Among other things, states and municipalities fund large scale projects like bridges, highways and other physical services with Treasury bonds. Higher yields make those projects cost more.
The federal government funds its debt by issuing Treasury bonds. Should the 10-year and other bonds yields return to their historical averages then it could cost taxpayers an additional $500 billion a year in interest costs just to maintain the national debt. A lot of good could be done with $500 billion!
Higher yields will mean that cash-strapped cities, counties and states can no longer afford upkeep on their crumbling infrastructures. That smothers job creation.
There is nothing to be alarmed about yet. U.S. Treasury 10-year yields are still far below their historical average of about 4.5%.
However, the last time yields were at normal levels the national debt was half the size it is today.
The U.S. dollar is the currency of world trade. About 70% of world commerce is conducted in dollars. Investment in U.S. Treasury securities has been a safe-haven investment for the whole world ever since the Great Recession struck.
As long as Treasury rates remain low the rest of the world will remain confident in the U.S. economy and the dollar. If yields rise to high, to quickly it could cause a confidence crisis that would have foreign investors sell off their U.S. Treasury holdings. That could have a downward spiraling effect of enormous consequences for the U.S. and world economies.
There is no danger of any of that yet, but keep a wary eye on Treasury yields over the next several months. They are the harbinger of things to come.