Treasury Bond Yields Rise

Treasury bond yields have risen quite a bit over the last 2 weeks. It started when Standard & Poor's announced it may downgrade England's top level sovereign AAA credit rating. It does this by attaching a negative outlook to the credit rating, meaning a downgrade could come in the future. In anticipation, U.K.'s interest costs are rising. Moody's affirmed U.S.'s AAA rating. Our debt crisis is not as bad as theirs! Plus, the U.S. dollar is still the primary global central bank reserve asset, giving a unique source of international demand which is translated into demand for our Treasury bonds. This prop is lessening but still there.

The Fed is trying to put a good face on the rising yields by pointing out that tentative signs of a global recovery are lowering the perceived risk of further financial catastrophe. This view has investors moving out of safe-haven Treasuries into higher-risk corporate bonds, stocks (we've certainly seen that!) and even emerging market stocks and bonds.

The fly in the ointment is that mortgage rates are tied to the 10-year bond yield, and they too are rising. The Fed wants to keep mortgage rates low to support housing and thus the increase in 10-year yields is not helpful. The Fed could counter by increasing its purchases of Treasury bonds and mortgage-backed securities. This will quite possibly be the topic "du jour" at the next FOMC (the Fed's policy making arm) meeting scheduled for June 23-24.

This week German Chancellor, Angela Merkel, chimed in on this. She said that the Fed, Bank of England and, to a lesser extent, the ECB (European Central Bank) have been too aggressive with the printing press. She warns that central banks may be perceived as losing some of their independence if they are seen as too willing to finance big-time government deficits. That perception, if it becomes widespread, will likely cause bond yields and mortgage interest rates to rise further. It could conceivably derail the nascent economic recovery.

Fed Chairman, Ben Bernanke, responded to the rising rates and the Chancellor's comments by warning the Federal government to speed up its time table to lower the Federal deficit. This, unfortunately, may be jaw-boning as they hope to talk interest rates down. Many of the cows have already left the barn on rising Federal deficits!

We all hope his message will be heeded soon by Team Obama and Congress, but recent signs suggest we are still heading toward higher deficits as we broach huge new expenditures on health care.