An interesting chart from the IMF showing the components of the 10-year Treasury yield. Note how oxymoronic credit risk (in pink) crept into the “risk-free” 10-year rate starting around the collapse of Bear Sterns. The IMF opines on what has driven yields from their 2.33 percent October low,
In sum, this analysis suggests that fiscal concerns do not appear to have led to a higher cost of funding during the most recent run-up in nominal bond yields. Rather, improving growth prospects and higher term premia are the main factors pressuring long-term rates higher. Furthermore, QE2 does not appear to have contained long-term rates. While the anticipation of QE2 initially led to a sharp compression in term premia, that impact was either fleeting or has been more than offset by other factors.
It’s an interesting exercise and just imagine where rates would be had not the FED effectively funded over 60 percent of the Q4 deficit. We believe Treasury yields are now one of the most distorted prices in the world. Except for the massive flight to quality during the financial collapse, foreign central bank recycling of BoP surpluses and now the Fed have been the marginal buyer of Treasuries (maybe not all 10-years) since mid-last decade. In fact, the Fed and foreign buyers effectively purchased the entire stock of new Treasury issuance in Q4.
Alan Greenspan even blamed foreign central banks for distorting interest rates and contributing to the housing bubble. Newsweek writes,
From early 2001 to June 2003, the Fed cut the overnight fed-funds rate from 6.5 percent to 1 percent. The idea was to prevent a brutal recession following the “tech bubble”—a policy Greenspan still supports. The trouble arose when the Fed started raising the funds rate in mid-2004 and mortgage rates didn’t follow as they usually did. What unexpectedly kept rates down, Greenspan says, were huge flows of foreign money, generated partially by trade surpluses, into U.S. bonds and mortgages.
So you think the distortion of the most important component of the credit allocation mechanism has anything to do with the credit crisis, the enabling of $1.5 TN budget deficits, and now why the private sector is hesitant to make long-term mortgages? We certainly do and look forward to seeing this chart updated after if the Cen Banks stop buying Treasuries.
Could it also be why the President is finally getting religion on the country’s fiscal position? We’re not certain where this all ends up, but it is certainly going to get very interesting. Stay tuned.
(click here if chart is not observable)
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