The Guest Blog

Crescenzi: 10 Reasons Why Treasury Yields are Falling


In addition to recent data showing weakness in the labor market, there are many factors causing Treasury yields to fall of late.

Here are ten of the most prominent:

1) Investors are skeptical about whether there will be a successful hand-off between the inventory- and fiscal-led sources of economic stimulus to more sustainable sources of demand. In other words, investors are unsure whether the recovery will reach escape velocity and make it on its own. Weak income growth, wealth destruction, diminished credibility, and increased regulation, make the hand-off challenging. Structural changes in the economy and low levels of economic activity relative to the "old normal," mean there will be a "new normal" of slower economic growth for some time.

2) A worldwide yield-grab is underway.

Investors have put their fears aside and have bought every risk asset under the sun in 2009, compressing yields and spurring a self-feeding reach for higher yields. The Federal Reserve has put a "curse on cash," pushing investors to move out the risk spectrum for additional yield. In Treasuries, increasing one's risk is accomplished by moving out the yield curve, which is what is happening and is flattening the yield curve.

3) Accentuating the yield grab in recent weeks is the Treasury's recent announcement that it would cut its Supplemental Financing Program (SFP) from $200 billion to $15 billion. In doing so, technical factors associated with it are causing the Fed to expand its balance by $185 billion over a several week period (the Treasury had deposited at the Fed the $200 billion it had borrowed from the public, which has the effect of draining reserves from the banking system because the public borrowing takes money out of the banking system; the paying back of the debts puts money back in the system). This is compressing short-term rates even further, putting a further curse on cash and emboldening investors to move out the yield curve.

4) Institutional investors widely expect the core inflation to decline, as it normally does in the aftermath of recessions, because it lags by as much as two years.

5) This means that real interest rates (the nominal, or stated yield minus inflation) have been attractive. Consider, for example, that the U.S. 10-year has yielded about 1.85 percentage points more than the consumer price index over the past 10 years. Moreover, the 10-year has tended to trade about 1.5 percentage points above the federal funds rate and the Fed has indicated that it won't move on rates for an extended period.

6) This might seem counter-intuitive but the Federal Reserve's recent hawkish commentary might also be pusing long-term rates lower. How? By showing resolve against inflation the Fed helps keep inflation expectations down, pressuring downward long-term interest rates. So long as the Fed emphasizes the "how" and not the "when," tough talk on inflation will win points with bond investors worried about the Fed's easy-money policies.

7) The Federal Reserve's most recent policy statement indicated it would purchase the entire $1.25 trillion of mortgage-backed securities it expected to purchase. The Fed had previously stated it would purchase "up to" $1.25 trillion. This means that more "duration," or risk, will be removed from balance sheets across Wall Street, opening up room for more fixed-income assets.

8) Banks, households, and other entities have been severaly underweight Treasuries in recent years relative to historical averages and hence they have become more active participants in recent months and are boosting their Treasury holdings. Recent data indicate a steady contraction in loans at the nation's commercial banks occuring amid steady increases in securities holdings, which account for about 20% of commercial bank assets.

9) Non-commercial futures traders have been short both 10- and 30-year Treasury futures and are as usual being caught on the wrong side of the market.

10) I am sticking with my oft-stated rule regarding Treasury supply: it matters only in bear markets for Treasuries and this is not a bear market. There are limits to this rule, because we don't know to what extent investors will show tolerance toward profligate U.S. spending, but this is probably not going to be an issue unless there is a second round of fiscal stimulus and lack of resolve toward tackling the budget situation.

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