The rise in the 10-year Treasury yield to its highest level since 2002 may or may not signal a secular change in the future supply of liquidity. But when it comes to interpreting the signal, strategic-minded investors should think strongly about erring on the side of caution. The advice is all the more relevant for those who’ve profited from the liquidity driven bull market of the past five years that’s dispensed gains in all the major asset classes.
For all we know, the current spike in interest rates may end tomorrow–or not. But when the bond market sends a message this crisp, we’re reluctant to dismiss it out of hand.
Then again, the rise in the 10-year yield isn’t all that astonishing, given the recent evidence that the economy’s still bubbling. For those who assume the economy’s not headed for recession any time soon, the case for an inverted yield curve (long rates below short rates) has been on shaky ground.
“We’ve been through a three- or four-year period where yield curves have been a weird shape,” said Tim Bond, head of asset allocation at Barclays Capital, told Reuters. “I think you’ve got further to go [with rising interest rates]; yield curves are just normalizing.”
No matter your view on where the economy’s going, the bond market has some very definite ideas. To be sure, the ideas of the moment stand in sharp contrast to the ideas of the recent past, as our chart below reminds. In fact, those ideas may change again.
The future, of course, is debatable; the past is set in stone. Looking at the carvings left by fixed-income trading reveals that something approaching a normal state may be coming in the relationship between yields and maturities. Using last night’s close as a guide, there now exists a 60-basis point spread in favor of the 10-year over the 1-month T-bill. At the close of last year, the 10-year’s yield was 10 basis points under the 1-month T-bill. On its face, the change implies that the economy will stay stronger than previously assumed. Now all we need is fresh data to support the bond market’s forecast.
But don’t hurt yourself looking. Long yields may be rising for any number of reasons, some of which don’t necessarily lend themselves to bullish notions about the economy. One example comes via Bloomberg News, which reported Federal Reserve Bank of Cleveland President Sandra Pianalto as saying that inflation is “uncomfortably high.”
Just to keep things interesting, however, there’s a wrench in the analytical machinery in the form of commentary from former Fed Chairman Alan Greenspan. The maestro of old, speaking yesterday at a conference in New York, warned that the low yield premiums on emerging market debt wasn’t long for this world. Again citing Bloomberg News, Greenspan advised that “all the spreads you are looking at, including your spreads relative to the 10-year, are going to start to open up and the 10-year is going to be moving as well.” The comment, we read, inspired the selling in the 10 year. If so, one might wonder if the rate jump is artificially induced by one Alan G.
No matter, as fundamentals will ultimately dictate prices. The truth, in short, will out. Maybe not today, but eventually and, we think, soon. Clarity is coming, albeit in small doses released irregularly and over time. Patience, more than ever, is a necessity as well as a virtue in these ambiguous financial times.