Sunday, January 25, 2009

It Appears the Coming Huge Spike in Interest Rates Has Begun

Despite double digit money printing, interest rates on Treasury securities are starting to climb.

From a low of 3.04 % on the Treasury's composite of Treasury securities with maturities greater than 20 years, the composite now stands at 3.53%.

Short-term Treasuries are also starting to climb, from a low of 0.07% on January 9, the 13 week coupon equivalent rate is o.11%.

WSJ reports on the factors behind the rising rates:
The rise in yields has occurred for a number of reasons. Government borrowing needs incurred as part of the response to the current financial market crisis have driven huge increases in borrowing. An $825 billion stimulus plan winding through Congress will almost certainly increase the supply of Treasurys further, and there are supply pressures coming from other markets, as well.

Emblematic of that sea of debt, the Treasury Department said on Thursday it will auction $30 billion in five-year notes, $40 billion in two-year notes and $8 billion in 20-year Treasury Inflation Protected Securities next week. Treasurys reacted to that, along with fears about China’s holdings of government debt, with a sell-off in long-dated issues that saw the benchmark 10-year note yield rise by 0.08 percentage points Thursday to 2.61%. Merrill noted the 10-year yield is half a percentage point higher now than it was in late December.

More supply will be coming, and at a certain point investors will demand even lower prices to absorb it all. The signs are that they have already started to seek those concessions, and there’s little clarity how much higher prices could rise.

WSJ suggests that the spike in rates may cause the Fed to begin to start buying long-term securities and quotes Merrill Lynch economists who believe the same:

Could a recent and steady rise in Treasury yields force the Federal Reserve to start buying in bulk longer-dated government bonds?

Merrill Lynch economists are warning that the answer may be “yes.” Economists David Rosenberg and Drew Matus said in a note to clients that despite the recent rise, yields are still historically low. All the same, Fed officials want those yields to stay down because that should in turn help stimulate overall economic activity... While Fed officials have only indicated it’s something they are mulling, they have nevertheless said that if other existing efforts prove insufficient they could ramp up purchases of longer-dated Treasurys in a bid to broadly lower borrowing costs. They’re already doing something similar with their purchases of agency and mortgage debt, an action that has helped drive a wave of refinancings, even as overall housing activity remains extremely strained.

The Merrill Lynch economists said it’s unclear how much the Fed would need to buy to goose government bond yields back down to the desired levels...

While the Merrill Lynch economists don’t address whether the Fed would have a target level for longer-dated Treasury yields, there’s some evidence that it wouldn’t. In a speech last week, Federal Reserve Bank of Atlanta President Dennis Lockhart welcomed the influence the Fed was having in the mortgage market via its purchases.

But he added “the goal of such a program is not, in my view, to engineer a particular interest rate level.” Lockhart said the Fed is instead interested in seeing a generalized drop in mortgage costs. It’s possible that if the Fed were to buy longer-dated Treasurys, it would operate under the same goals

Bottom line: The Fed is out of control, government spending is out of control, and this is all highly inflationary.

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