Throughout the year, we have discussed the bond market in relation to the economic recovery and the amount of money awash in the market. Well, this week we saw yields pop to multi-month highs. We have a convergence of things happening that are not good for bonds.
First, the government is borrowing a LOT of money. They will auction over $100 billion in treasuries next week to pay for all the spending. Second, the economy looks like it is starting to pick up. People who buy treasuries are starting to demand more interest for taking on the risk of inflation that seems to be gathering. When the economy is dead in the water, it is hard for inflation to get going. If the economy picks up that changes. This makes perfect sense. For the foreseeable future, the U.S. government most likely will just keep issuing these bonds, so there will be plenty of supply. The demand has started to get overwhelmed.
The Fed keeps saying it wants to keep rates low because of the employment situation. However, they control short term rates. The market prices the longer dated securities. The problem can be exacerbated if the Fed keeps rates too low. Investors typically fear inflation more if they feel the government is not trying to stay ahead of it by starting to restrict the supply of money in the market. The way the government can do that is by raising short-term rates. It seems counter-intuitive, but if the Fed raises short-term rates, it may at some point start to lower longer-term rates. That typically happens towards the end of the tightening cycle (when people fear they may have restricted it too far).
One byproduct of higher long-term rates: higher mortgage rates, which the housing market does not need right now….
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Tags: bonds, treasury auction
