Bond Vigilantes Wrong on US Debt: Economist

Investors like PIMCO’s Bill Gross predict the rally in Treasurys will have to come to an end sooner rather than later, but one economist predicts the yield on the 10 year bond will hit 2.5 percent.

The Federal Reserve headquarters in Washington, DC.
The Federal Reserve headquarters in Washington, DC.

“To some, this rally must inevitably come to an end soon. After all, the Fed’s second round of quantitative easing draws to a close this month and the US public finances are in dire straits. We disagree and continue to expect the 10-year yield to hit 2.5 percent by year end,” said John Higgins, the senior market economist at Capital Economics in a research note on Friday.

The main reason for Higgins to take issue with the bond vigilantes is his belief that US borrowing costs will not rise this year or next.

“We expect the rate to still be between 0 percent and 0.25 percent come the end of 2012,” he said.

“There is certainly no need for the Fed to raise rates in order to tackle inflation. While upward pressure on commodity prices has pushed up the headline rate of US PCE inflation to 2.2 percent, the core rate – excluding food and energy – is still only 1 percent.”

Commodity prices have started to fall and should fall further as demand eases, according to Higgins further easing fears over inflation.

“Judging by the decline in break even inflation rates on Treasurys over the past month, investors are waking up to the reality that inflation is not a problem,” he wrote.

With the market focused on Friday's US labor report, Higgins predicts unemployment will remain over eight percent until 2013 at the earliest, giving the Fed even less reason to raise rates.