Thursday, December 24, 2009

Are Treasury bond yields headed (much) higher?

Theory says the ten-year risk-free bond yield should be equal to nominal GDP growth. With inflation expectations currently at 2.25% or above and consensus GDP growth for 2010 at 2.5% and above, the 10-Y Treasury bond yield could easily rise to 4.75% in the first part of the year, which incidentally, is about the level it averaged during the past half-decade.

However, I am expecting both renewed credit concerns and disappointments regarding GDP growth. This should at least put a cap on bond yields at around 4.75%. Since I am quite pessimistic in assessment of the economy, we should also see at some point a renewed flight to quality (well, quality is becoming less and less appropriate to describe treasuries) which could bring yields back towards 3-3.5%.

To sum up, 2010 could see swings in yields almost as wide as those we have seen in 2009.

To break the 4.75% level, we are going to need to witness "tangible" inflation concerns, and this should not be a problem before 2011 at least.

1 comment:

  1. Raphael, I agree with your assessment. Investors fled to Treasuries for safety, making them overbought in 2009. Investors are now are exiting toward riskier corporate junk which is causing Treasury yields to return to pre-crisis levels. This is being misinterpreted in the market as a signal of anticipated inflation.

    The job news lately is also being misinterpreted by the market as a recovery. Unemployment is likely to climb for another 12 months, if the last two recessions are any indicator. Also problematic is that the median duration of unemployment is much higher than any other recession so far.

    http://research.stlouisfed.org/fred2/series/UEMPMEAN?cid=12

    http://research.stlouisfed.org/fred2/series/UNRATE?cid=12

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