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What is fair value for the 10-year Treasury?

Traders work on the floor of the New York Stock Exchange.
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Traders work on the floor of the New York Stock Exchange.

What is fair value for the 10-year Treasury? That's the big question for the moment, but nobody knows. What's the right interest rate? You could make a few simple observations that should get you close: growth is low (say, 1.5 to 2 percent GDP), inflation is contained (below 2 percent).

Present these facts to most economists, and most will say that with the 10-year yielding 2.8 percent we are not far off from fair value. One bond strategist I spoke with yesterday has a range of 3 to 3.5 percent for this year.

The median forecast for bond analysts is for a 10-year yield of 3.25 percent for the end of 2014.

The problem, of course, is that models of fair value don't work well when the Fed is involved. The steepness of the curve is a measure of future inflation and growth expectations. We don't have either, but we do have a steeper yield curve. The current spread is 243 basis points (the difference between the 10-year and two-year Treasury).

(Read more: Will US yield spike derail tapering plans?)

That is likely too steep given the fundamentals. It suggests that the yield on the 10-year is currently too high.

What's it mean? It means the market is having a difficult time adjusting to the taper. The market is building in a higher risk premium than fundamentals would dictate.

What will change this? It's a maturation process—the market has to find a level on its own.

One thing's for sure: If we continue to have these poor growth outlooks and sub-par inflation, the bond market will have to readjust itself.

In the meantime, small events like Jackson Hole on August 22-24 take on greater significance, despite the absence of Mr. Bernanke and the ECB's Mario Draghi. Some guidance—any guidance—is what traders crave to get closer to the "right" yield.

Elsewhere:

1) It may be a lousy week for stocks, but investors keep putting money into the market. Stock mutual funds see their 32nd straight week of inflows, raking in $2.56 billion in the week ended Wednesday, according to Lipper. However, there were $1.6 billion in outflows from equity ETFs. Bond mutual funds also attracted money, gathering $1.25 billion in the past week.

(Watch: Santelli Exchange Extra: The great 'inflow')

2) Even the higher-end retailers are having a tough time. Nordstrom reported slower than anticipated same-store sales (4.4 percent, below expectations of 6.8 percent) and Q2 earnings of $0.93, below expectations of $0.88. The company also lowered its sales and earnings guidance for the second half. Even the anniversary sale in July generated only low single-digit gains.

Stifel, in a note to clients, summarized the current standard line on the disappointing retail earnings: "We believe that the consumer has de-emphasized their apparel consumption as we have observed a renewed interest in 'big ticket' consumption, including cars, vacations and homes."

3) Gold rally: what's behind it? Lots of confusion about the sharp jump in gold yesterday, with many explanations. Regardless of yesterday's rise, everyone believes there has been strong physical demand for gold, particularly in China, where there has been an improvement in the economy. This has offset the weaker holdings from gold ETFs. Tensions in Egypt and reports of record high short contracts on Comex may also be a factor.

George Gero, a veteran gold trader at RBC and an old friend, also offered this explanation: High rates have caused lease rates to jump for those who need to borrow gold in order to hedge. Miners typically borrow gold, then sell the forward month and replace it with future production. Their cost for borrowing has risen. Those borrowing gold have two choices: cover their shorts, or pay higher rates. Some appear to be covering shorts.

Still, it's been tough for gold recently. In a report issued yesterday, the World Gold Council noted demand for gold hit a four-year low in the second quarter, although demand for physical gold remained strong. JPMorgan put a note out this morning: "Gold and the Denver play: Gold Shrugs Off the Paulson Sale; Buy the Bounce," which argued that Paulson & Co. had cut its exposure to the gold ETF in half, but it had not hurt the market and that this was a time to buy gold.

4) U.S. lags global markets this week, a week when emerging market countries did a bit better.

Global Indices This Week

S&P 500 -1.8%

Brazil 2.3%

China 0.8%

Spain 0.5%

Japan 0.3%

Germany 0.1%

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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