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What Is Going On In the Bond Market?

Posted by Larry Doyle on December 15, 2010 7:02 AM |

Interest rates globally have moved up approximately 50 basis points (.5%) over the last month with the bulk of that move having occurred in the last week. What is going on? What is driving this move higher? A harbinger of better days ahead or an indication that the massive deficits in selected nations will require higher rates to attract capital? Or both of these reasons and a lot more. Let’s navigate.

1. First things first, even with the backup in rates recently, let’s be cognizant that for the year the 10yr US Treasury rate is lower by approximately 50 basis points.

2. What global bond market has had the biggest rout recently? Spain. Spanish 10-year bonds have backed up almost a full 100 basis points (1.0%) over the last month. ¬†Overnight Spain was put on a watch list by Moody’s for a potential downgrade. While the fiscal mess in Ireland is off the front page for the time being, the massive fiscal deficits in the peripheral nations of Europe remain and will definitely require higher rates to attract capital. As European bonds sell off, our bond market is not about to stand still.

3. Improving emerging economies will need to continue to raise rates in order to stem the prospects of higher inflation. That reality will drive rates higher globally as well.

4. What domestic issues are driving our rates higher? I see two major factors:
>The municipal bond market is backing up quickly as the Build America Bond program will very likely be discontinued. That reality is causing a wave of supply to hit the market prior to year end. Investors are demanding higher rates to fund these deals.
>The likely passage of the tax package extending the Bush tax cuts is viewed as an economic positive BUT also a net negative in terms of increasing our deficit.

The BIG question for investors, though, is whether this increase in rates is a reflection of real structural improvement in our underlying economy and will we see job growth? The jury remains out on that question–but call me doubtful.

I would ask, if the economy is improving, WHY does the Fed still see a need for quantitative easing. Additionally, is the market sending a major middle finger salute to Ben Bernanke and Tim Geithner? I believe so. How’s that? Even in the face of the Fed being a $600 billion buyer in the market, our rates are headed higher to attract REAL money and REAL investors to fund our massive federal and municipal deficits.

Additionally we should be aware that a government–that being the US of A–that is willing to devalue its currency–and it is–in order to deal with its deficit is a much higher risk for investors.

Navigate accordingly.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed here are my own and not those of Greenwich Investment Management. As the President of Greenwich Investment Management, an SEC regulated privately held registered investment adviser, I am merely a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

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