The Bond Boys Come Out Swinging

Now this chart is either really good news or dark storm clouds on the horizon…

Treasury yields are heading skyward, as the bond market begins to realize that a) the economy is improving, b) monetary policy is incredibly expansionary, and c) fiscal policy is creating massive financing needs. This is a perfect storm for the Treasury market, and it could send yields far higher in short order.

The silver lining to this thunderstorm cloud is that it may cause our politicians to rethink their plans to spend money like a drunken sailor. It would be great if Obama came to have the same respect for the bond market as Bill Clinton did.

“Davidson” says of it all:

This piece by Scott Grannis begs the question: “Would Bernanke reigning in stimulus boost market confidence?” There are many indications that confidence in the credit markets have improved. It is understood that if lender’s confidence levels continued to improve as has been apparent then many of the looming refinance issues for commercial real estate would ease. The effect on lender’s confidence in the auto loan and home loan market could continue to improve which would go a long way towards easing fears of the after-effects of a GM bailout or easing the fears of Alt-A mtg rollovers.

If Bernanke declares that now is the time to reduce the stimulus, would this rein in the fears of pending inflation, boost lender confidence and stimulate economic improvement?

Confidence in our financial system is crucial to our society. It is the lack of confidence which causes deep recessions as everyone retrenches at once. It is the excess confidence that produces bubbles as many over extend themselves.

A boost to confidence would be welcome.

My two cents:

Obama is learning (hopefully) that all his spending plans can be put on hold by the “Bond Boys”. Much as Clinton learned, should they not like the direction things are going, they have the ability to drive up interest rates.

Why is that a problem?

Consider a second chart, this one of 30 year mortgage rates

Look great right? What better to help spur housing except record low rates! But, look at the relationship between the 10yr. Treasury and the 30yr. mortgage. The 30 yr. on average tends to run about 1.7% greater than the 10yr.

So…….why does this matter? Well the 10yr. exploded to 3.5% today and that correlates to an appoximiate 30yr. rate of 5.2% upcoming or over 1/2 a point higher than just a week and a half ago. Nothing, and I mean nothing will throw more cold water on this housing market that rapidly rising interest rates. Folks who were sitting on the fence just a week or two ago are going to be in for quite a shock when they look at the new monthly cost of a house.

Now, here is where “Davidson’s” comment on Bernanke comes in. Should Ben decide it is time to suck some liquidity out of the economy “due to its performance”, we would see a reversal of the the rate jump. That might also have the effect of spurring those folks on the house buying fence out there the rush out and pick one up as they fear additional rate increases. This would be good news.

The huge risk is “what if there really aren’t any buyers on the fence”? Rate increases will only serve in this case to deepen the problem and Bernanke’s withdrawing of liquidity would serve to further tighten lending.

What really needs to happen? We need some responsibility out of Congress and the White House. If we cannot get it then the bond folks will force it on them and in that case, options become very limited very fast. The first volley has been tossed, let’s see what happens now..

Disclosure (“none” means no position):

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