Uncertainty Keeps U.S. Treasury Yields Aloft

 | Feb 26, 2013 | 2:00 PM EST
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Yields on 10-year Treasuries in the world's three largest debt-issuing countries, the U.S., Germany and Japan, have all been declining over the past week.

The German and Japanese yields, however, have been declining for the past month, even as U.S. yields have stayed in the 2% range.

The 10-year yield in Germany has declined from a recent high of 1.69% on Jan. 29 to 1.27% today. The Japanese yield has declined from 0.81% on Feb. 4 to 0.69% today.

The U.S. yield, however, began to decline only in the past week from a recent high of 2.03% to 1.87% this morning.

Financial analysts across all asset classes have been fixated this year on trying to determine when the Federal Reserve will begin to withdraw stimulus, allowing long-end yields to rise again. This has caused the yields on long-end U.S. Treasuries to remain elevated in comparison with those in Germany and Japan.

The expectations of increasing stimulus in Japan coupled with steadily lower long-end yields there should logically have caused U.S. bond traders to anticipate that Japanese investors would increase their carry trades into U.S. debt, causing yields on U.S. debt to decline as well.

Fear that the Fed will end its support for Treasuries and mortgage-backed securities by indicating a withdrawal from QE 3 and 4 has proven to be a greater concern for global bond buyers than anything else.

It has proven so far to be greater than economic fundamentals or the actions taken by either the European Central Bank or the Bank of Japan.

This fear has been exacerbated by Fed Chairman Ben Bernanke's reticence with respect to the Fed's intentions, which some interpret as meaning that he may be concerned about the prospect of having to withdraw QE 3 and 4 sooner than anticipated.

However, outside of the increases and increasing rates of housing and auto sales over the past year, there is still little evidence that the U.S. economy is doing anything other than stagnating. Unemployment figures, initial jobless claims, the Consumer Price Index, wages, productivity, freight and shipping indices, the ISM manufacturing and non-manufacturing indices and GDP overall are all indicating a flat U.S. economy that could easily revert to even slower growth.  

And yet global bond market participants appear convinced that the U.S. is on the verge of a growth trajectory that will require the Fed to exit QE3 and 4 sooner than anticipated.   

Bernanke will testify before the U.S. Senate today, and although he will likely not address the Fed's plans for QE3 and 4, it is logical to anticipate that he will have to acknowledge that the majority of the U.S. economic indicators do not validate concerns about inflation.

This should provide the rationale necessary for bond traders and investors to put aside their concerns about a Fed exit and begin to buy U.S. Treasuries. This should allow U.S. 10-year yields to decline to where they were at the beginning of the year, in the 1.75% range, and perhaps as low as 1.6%, which is where they were in early December, the last time the Japanese yields were in the 0.7% range.

This would also cause 30-year fixed-rate mortgages in the U.S. to decline back toward their 2012 low of about 3.25% at par, from the current level of 3.75%. 

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