A Long US Holiday For The Bond Vigilantes

Bond vigilantes are driving yields higher for certain European countries, but there’s little sign of stress in the U.S. Treasury market. The dollar is hardly perfect, but it’s still the world’s reserve currency and it claims a number of benefits over the euro. Even so, the low yields on Treasuries is surprising to some considering the surge of predictions that the fiscal and monetary stimulus in recent years would eventually drive yields skyward. In 2009, for instance, The Wall Street Journal argued that the vigilantes “appear to be returning with a vengeance now that Congress and the Federal Reserve have flooded the world with dollars to beat the recession.” Two years on, the benchmark 10-year Treasury yield is roughly 2.9% as of yesterday, or about 50 basis points lower than when the Journal expressed its concerns about the blowback from vigilantes on May 29, 2009.

According to some analysts, these are still ripe times for soaring Treasury yields. The Federal Reserve’s program of buying government debt (QE2) ended last month, thereby removing some of the downward pressure on yields. There’s also worries over whether Congress will raise the debt ceiling in early August and avert a technical default on Treasury debt, an event that, if it happens, could trigger a new financial and economic crisis, according to some economists. But despite these dark clouds, Treasury yields remain relatively subdued.

It’s the same story for the Treasury market’s inflation forecast, based on the yield spread between the nominal 10-year Note less its 10-year inflation-indexed counterpart. By that measure, the crowd’s expecting inflation of around 2.4% a year for the decade ahead, which is more or less the average reported over the last decade.

Is any of this surprising? Not really. Yields and inflation expectations are low in the U.S. because of the ongoing fallout from the massive financial crisis of 2008 and the lingering economic ills that followed. The unemployment rate remains high, job creation is still tepid, and the demand for safe havens, such as gold and Treasuries, is above average. Paying down the excesses of debt accumulation in years past is now a priority, which means consumption and economic growth are on the defensive. It’s an old story at this point, but it’s still the main narrative.
Some analysts are confused by these events, arguing that higher yields are just around the corner. That’s true for Greece and Spain, for example, but it’s wrong to assume that the conditions in those countries have a direct analogy with the U.S. A more telling analysis for America is the history of financial crises, which suggests that slow and middling recovery will roll on for some time.
The market seems to anticipate no less. Indeed, the demand for money is still robust. “U.S. Treasury bill yields not far above zero were no deterrent on Tuesday to demand in an auction of $28 billion of four week bills which was underpinned by tight supply and safe-haven buying,” Reuters reports. “The U.S. Treasury on Tuesday auctioned the bills at a high rate of 0.005 percent, down from 0.02 percent in a similar auction last week, but up marginally from a high rate of zero in a four-week bill auction two weeks ago.”
The same demand for a safe haven (as opposed to a fear of higher inflation) is probably driving gold prices skyward as well. Not everyone agrees. One theory is that gold prices reached $1600 an ounce for the first time in recent days because, as one writer opined, of worries over U.S. fiscal and monetary policies. Perhaps, but then why is demand for Treasuries so strong at this late date?
The answer seems to be that we’re still suffering from the after-effects of a huge debt crisis. As David Leonhardt reminds, balance sheet recessions and their aftermaths are especially persistent and pernicious beasts and so it takes an unusually long period of time for something approaching a normal recovery to take root. The latest reading on consumer confidence, which just hit a 2-1/2 year low, surely doesn’t change the historical perspective.
Yes, a more aggressive monetary policy might be able to speed the recovery process, although that hope is fading, i.e., a potent QE3 is off the table, at least for now. Ditto for thinking that a new fiscal stimulus will bring salvation.
Meantime, the case for arguing that the bond vigilantes are poised to return in the near future in the U.S. Treasury market still looks like a long shot. The history of financial crises doesn’t repeat, but it does rhyme.