Is the bond market getting ahead of itself on the U.S. recovery?
The yield on the benchmark 10-year Treasury note rose to 3% Thursday for the first time in three months, amid signs that the U.S. economy is starting to warm up.
The last time the 10-year note traded at 3% was July 29, the day St. Louis Fed President James Bullard roiled bond markets by issuing a paper weighing the steps the Fed could take to avoid a damaging spiral of falling prices and wages.
You might then take the recent Treasury selloff, capped by Thursday’s action, as evidence that deflation has been vanquished. The in crowd has been saying something just like that lately.
“We believe bond yields have seen their cyclical trough,” Goldman Sachs economist Dominic Wilson said this week as the firm lifted its U.S. growth forecast.
But even many of those who share Goldman’s view that the U.S. rebound is picking up pace are skeptical that the Treasury bond selloff will continue.
They see signs the economy will remain weak well into next year, if not as weak as previously feared. What’s more, the Federal Reserve’s plan to buy $600 billion of Treasury bonds over eight months should put a floor under bond prices, and keep yields from sailing too high.
“A card laid is a card played for the Fed,” said UBS economist Maury Harris. “The first part of next year the Fed is going to keep banging away with those bond purchases, so I wouldn’t see a sustained upward push in yields for a while.”
UBS this week forecast that the U.S. economy will expand 2.7% in inflation-adjusted terms next year, putting it in line with Goldman’s view and slightly above the Wall Street consensus. The firm says it expects easing lending standards to boost job growth and consumption spending. Both UBS and Goldman say they expect inflation to stay low in coming months, below the Fed’s informal target near 2%.
But in contrast to Goldman, which now sees the 10-year Treasury rising to 3.25% by the end of next year and 3.75% in 2012, UBS believes yields will stay below 3% for most of the next year.
The firm’s forecast for the end of this year has the 10-year Treasury at 2.5%, which is roughly where the yield bottomed in October before sentiment on the U.S. recovery started to shift. Why so low?
Because just as the naysayers gained the upper hand this summer, only to find their view unsupported by incoming data, there are signs the optimists are now getting a bit ahead of themselves.
“In August and September you had people wondering if Bernanke knew something they didn’t,” said Harris. “Now you’re starting to see evidence the pessimists have been wrong. But I still don’t think you’re going to have some runaway economy that’s going to push rates up.”
He sees the 10-year Treasury rising to 3% only at the end of 2011, by which time he expects the Fed’s quantitative easing program will have ended.
The setup is not unlike the one that prevailed in April, when the 10-year Treasury yield briefly spiked to 4% before starting a long tumble that was fed in part by weakening U.S. employment data.
The difference this time is that if the latest rebound disappoints, there is much less room for yields to fall – which is why some strategists remain focused on the risks tied to a long, slow rise in rates.
“It doesn’t take much at these levels to move the dial,” said George Rusnak, a fixed income strategist at the Wells Fargo Private Bank.