Yves here. As Wolf describes, in our brave new work of super-low interest rates, the 10 year Treasury breaching 3% was regarded with fear and loathing by the officialdom. Now with the Fed’s reassurances that the Fed funds rate will remain at just about zero for the foreseeable future, the stock market has popped the Champagne. But will the impact of the withdrawal of support for bond prices impact stocks sooner than the current rally would have you believe?
By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Testosterone Pit.
Treasuries have been skidding, and yields have been on a tear. Today the 10-year yield hit the psycho-sound barrier of 3%. What happened last time this phenomenon occurred? Well, yields bounced off and fell – because the mayhem they’d triggered around the world gave the Fed conniptions and caused it to back off.
The last time the 10-year yield hit 3% was in early September, for the briefest moment. But the last time it traded above 3% for any period of time was in 2011. In February that year, it spiked to nearly 4% as QE was petering out. That gave the Fed cold feet, and it unleashed another wave of QE which drove yields down to 2% by the end of 2011, and to a ludicrous 1.38% in July 2012.
Ludicrous because it just about guaranteed hapless investors a loss. If they sell it as yields are rising and values are tumbling, there would be a loss of capital. If they hold this paper to maturity, inflation would eat up its value and coupon payments would not be enough to compensate for it. Take your pick!
The Fed is trying to stir up 2% inflation, as measured by the core PCE index, which is even more unrealistic for households than the regular CPI. In this scenario, inflation as measured by the CPI might be 2.5% or more, sending the Fed to nirvana, and holders of these notes to bondholder purgatory. They’d lend money to the government for ten years at a loss. Conversely, with the government (and many corporations) borrowing at a profit, it would be smart to go on a borrowing binge, no matter what. That you can’t manipulate a wheezing economy back to health over the long term based on this lofty principle is obvious to all but perhaps the primary beneficiaries, our over-indebted corporate America, the Fed, and the government.
But it did lead to equally ludicrously low mortgage rates and to a historic junk-bond bubble with yields of these risky things dropping below the interest that 5-year FDIC-insured CDs used to pay before the Fed purposefully mucked up the lives of savers. In broader terms, it lead to the most gigantic credit bubble mankind has ever seen. Risks no longer mattered, and pricing of risk was removed from investment equations. What it did not lead to was vibrant economic growth.
But in May, taper talk started bubbling up and turned into the taper tantrum over the summer. Bonds fell hard, and 10-year treasury yields soared from 1.61% in early May to 3.01% in early September – nearly doubling in four months. Municipal bonds got clobbered. Mortgage rates soared, rendering homes, whose prices had been shooting up for a couple of years, much more expensive to buy. Emerging markets got the jitters. Their currencies fell off a cliff, and their inflation rates roared ahead. This 3%-land suddenly looked scary.
The Fed got cold feet once again and backed off its taper threat, and yields plunged again. Well, a little. They bottomed out in October, with the 10-year yield approaching 2.5%. Then yields turned around, and now, with taper talk back on track, and the first $10-billion slice scheduled to take effect in January, the 10-year yield pierced the psycho-sound barrier of 3% for the second time this year.
Yet the Fed hasn’t actually done anything. It’s still just talking. And it’s still printing $85 billion a month to buy Treasuries and Mortgage Backed Securities. These moves in the bond market are simply in anticipation of what might happen when or if the Fed actually tapers.
Those hapless souls who bought treasuries with longer maturities in the summer of 2012 are contemplating massive losses. They were tricked and fooled and hoodwinked by the Fed. So be it. But Treasury yields impact the real economy too, where people are struggling to get by and where homebuyers have to re-figure out how much of a house they can afford, given skyrocketing home prices and soaring mortgage rates.
Rates for 30-year fixed-rate mortgages with conforming loan balances ($417,000 or less) hit 4.64% just in time for Christmas, up from 3.59% in early May, and retail homebuyers – not private equity funds and sundry investors – have pulled back. The Mortgage Bankers Association’s Purchase Index dropped 11% below the same week last year – as interest costs paid by homeowners on these mortgages have jumped by nearly 30% in seven months [read…. The Multi-Pronged Mortgage Debacle Next Year (So Long, “Housing Recovery”).
It remains to be seen if the 3% yield on the 10-year Treasury was just a brief foray into utterly forbidden territory during thin holiday-season trading, a forgettable event with little impact and no long-term consequences, or if it was a sign of things to come when the Fed actually starts tapering its bond purchases, and when the cost of borrowing money for the longer term might be allowed to meander back up to where it would normally be in a less manipulated but saner economy.