Sunday, August 09, 2009

Thoughts on Rising Treasury Yields

The chart nicely shows how 10-year Treasury rates have moved steadily higher as stocks bottomed in March and moved to bull highs this past week. Interestingly, those yields have not also made new highs, though they are approaching the 4% level registered in June.

With the Fed keeping short rates low, the steepening yield curve is helpful to banks, who can borrow cheap and lend dear. At the same time, rising rates make it more expensive for businesses and prospective homeowners to borrow, creating headwinds for the economy.

I continue to believe that few investment decisions are as important as the one between future inflationary and deflationary pressures. In the face of rising Treasury funding needs and a weak dollar, falling bond prices and rising yields might be expected. In the face of continued economic weakness and ongoing stimulus, a la Japan, we could see a very extended period of low rates.

If one assumes hyperinflationary pressures, locking in safe 4% returns sounds like a most unsafe strategy. In a deflationary environment, those returns could look juicy several years out. This is a Fed that has made its intention to fight deflation known. Once the current rounds of stimulus have run their course, the next round could take the form of purchasing Treasuries further out on the yield curve. That would make the bull market's rise in yields an attractive, if somewhat discouraging, proposition.