What’s Up With the 10 Year Treasury Yield?

Posted by Michael A. Kamperman on May 28, 2009

The Fed has a tiger by the tail.  It had best not let go.  The bond market has pushed the yield on the 10 year Treasury up to 3.75% today.  This has caused 30 year fixed rate mortgages to move back above 5%.  The data on housing says that 12% of all U.S. mortgages are now either delinquent or in foreclosure.  Rising interest rates will only drive the value of homes lower.  So the Fed is faced with how to handle interest rates that are getting pushed up by the Wall Street re-inflation crowd and speculators while real prices for homes and cars are getting pushed down on Main Street.  It is now gut check time for Ben Bernanke and the Fed. 

The dilemma faced by the Fed is multi-faceted.  First and foremost the huge budget deficit is requiring a record amount of U.S. Treasury bonds to be issued in the coming months.   This comes at a time when real wealth and profits are not being generated by most companies and by most foreign governments.  So the question needs to be answered whether or not there is enough capital out there to absorb all of the new supply.  The rising yields also come at a time when the re-inflation crowd is pounding the table that hyper-inflation is just around the corner.  Since the Fed is printing money and you had better grab all the hard assets you can to protect yourself.  Ironically, the higher these interest rates go the longer it will take to get out of the deflationary depression the country has entered.  Yet the more the Fed prints the more the inflation hawks squawk.

Getting yields back down needs to be the primary focus of the Fed.  But the gut check comes because the Fed will have to decide what they think the real reason is that rates are rising.  Is it because there is plenty of capital in the world and a recovery is near, creating a legitimate fear that the Fed doesn’t have a clear strategy to drain liquidity from the system?  Or is it because there is a shortage of capital in the world, hence the supply of Treasuries is competing with other investments forcing yields higher.  The Fed needs to choose the true answer and not the perceived answer.  If the economy is about to recover and the Fed ups its printing schedule, we will see a return of inflation.  But if the economy is not on the verge of recovery and the Fed stops quantitative easing, then the economy will crash further with even more severe bouts of deflation.  With 1 in 8 homeowners behind on their mortgages and no sign that unemployment rates are abating, I believe there is a shortage of capital in the world and the Fed needs to increase its rate of quantitative easing and slam the yield on the 10 year Treasury back down.