Interest rates at US government bond auctions continued higher this week—seemingly confirming fears over foreign funding, financing the deficit, inflation, and a faltering economic recovery.
Most of these concerns are largely unfounded, and government bond yields typically rise ahead of economic recoveries.
"Can we get three and a half? Three and a half? We've got three and a half. Now four? Let's have a four. Okay! Four on the floor—care to go one more? One more? Can I get a five? Five? Five's alive? No bidders on five. Sold at a fire sale four to the lucky gentleman in the back. Enjoy your shiny new US government Treasury bond, sir."
These are heady days for US government bond auctions—$19 billion in 10-year US Treasuries sold Wednesday, with an additional $11 billion in 30-year notes going up for auction Thursday (just a sliver of the trillion-plus expansion of the US money supply and deficit financing). But rising 10-year rates—briefly brushing 4% Wednesday—continue to cause concern. That in itself is amazing, considering 4% is actually well below the historic average. Yet the spike in government yields seems to confirm fears foreign lenders are finally pooh-poohing the dollar as their primary reserve currency, inflation is looming, and the federal government is finding it increasingly difficult to fund massive deficits. Even worse, it seems higher Treasury rates must soon trickle through to the private sector, stalling economic recovery.
Well, maybe—maybe not.
It's true, there has been a lot of huffing over the dollar as reserve currency—and Russia and Brazil recently joined China in claiming they'll move away from dollar dependence. But as we've said before, such talk is mostly smoke and mirrors and has gone on forever. It would actually be weird if such jawboning ceased. Foreign central banks haven't gone anywhere yet, buying an above-average $75 billion of Treasuries in the last month or so. And though investors are demanding higher yields from Treasuries, the feds aren't having trouble financing the deficit. Bids for Treasuries in recent auctions have been more than double supply. (Though keep in mind, so-called demand indicators, like "coverage," will fluctuate significantly week to week, depending on buyers' schedules—they're not necessarily indicative of overall demand.) Fine and good, but aren't higher yields signaling inflation? Probably not yet. As long as capacity utilization stays low, inflation will likely be tame.
So if it's not fleeing foreign lenders, flagging demand, or inflation expectations—what the heck is driving rates up? For one, interest rates fell dramatically to historic lows during the height of the financial crisis. Folks were even willing to accept negative yields in some cases. Some reversion to more normal rates makes perfect sense—pretty clearly, a lot of that money isn't going under mattresses anymore but contributing to the rally in more volatile assets like stocks.
Though sharper than usual this time around, government yields usually fall during recessions—and bounce during recoveries. Uncertainty in a recession makes business investment riskier, so investors shun corporate stocks and bonds, preferring government issues instead. Uncertainty this time around was particularly acute (as is logical in the case of a financial panic)—and so was the decline in yields. When business prospects look up, investors typically plough cash back into higher returning assets, and government yields rise. At some point, yields will rise enough to lure some folks back again, capping any runaway rate increase—and limiting the risk higher rates will upset economic recovery.
Future Treasury auctions may find four (or even more) on the floor—but as long as rates remain historically tame, slightly costlier borrowing may be one more reason to believe recovery is in the offing.