A Simple Explanation for Bond Yields
We've talked in the past about trades that are too one-sided. We've seen the U.S. dollar rally when everyone was looking for it to collapse. We've seen housing stocks rally in a dead housing market.
And most recently, we've seen bond yields rally in the face of a Fed policy that was supposed to keep yields contained.
Are we seeing the market repudiate the Fed's Treasury buying program? Are higher yields a statement that inflation is on the way?
There are plenty of analysts and economists that think QE2 is a bad idea. I've been one of them.
And even now, as economic data improves to the point that GDP forecasts are moving higher, the Fed appears steadfast that the economy needs more stimulus. The language in yesterday's FOMC statement was unchanged.
The inflationary risks of QE2 have been well articulated by the anti-Fed crowd. And even though today's CPI number shows that inflation is not happening, it's easy to interpret the rise in bond yields as sign that inflation is right around the corner.
If employment picks up, inflation may become a risk. But until that happens, there's another way to interpret the rise in bond yields: maybe yields are rising simply because investors are selling bonds
Here's a one-year chart that shows the yield of the 10-year Treasury. It's made a big move since early November. But let's look at the action for the 20+ Treasury bond ETF, TLT.
It's pretty hard to miss the huge volume surge that started in November, when the Fed actually announced its QE2 plans.
At its most simple level, a market is made of buyers and sellers. When there are more sellers, prices fall. In the case of bonds, more sellers means prices fall and yields rise. Maybe this is a good time to think of bonds in terms of buyers and sellers, rather than inflation.
Here's a headline from Seeking Alpha, a popular investment website: QE2 Is a Failure Higher Yields Will Hurt Overbought Stocks.
Maybe this headline is completely wrong. Maybe investors are selling bonds because stocks are the place to be as the economy improves. Higher bond yields certainly haven't been pulling buyers away from stocks so far...
*****It seems to me that there has been a consistent drumbeat of bearishness for the last two years. From them, we hear that banks are still insolvent, European debt will spread, China's going to dump Treasuries, a double dip of recession is coming, the U.S. dollar will cease to be the world's reserve currency, and so on.
Yes, bearish arguments always sound far more intelligent and informed than bullish arguments. I'm not taking any victory laps just yet. There a plenty of potential speed bumps out there.
But overall, the bears have won a few battles and the bulls are winning the war.
*****Now, turning to stocks, the major indices seem to be getting pretty comfortable at current levels. In the current environment, that will likely lead to an upside move.
We will turn our attention to what will happen in
the first few weeks of 2011 soon enough. For now, keep your eye on the
upside.
