Watch the 10-Year Treasury
We are in an interesting place with the ten-year Treasury rate. While not conclusive, we want to watch the behavior of the rate on this maturity when economic news is announced. If it appears that weak economic news does not cause the ten-year yield to decline, then caution may be warranted. By that I mean that the markets may have shifted their focus from the Fed to the fiscal deficit of the USA.
The background is one of a Fed that is letting their bonds mature (adding to supply) while the Treasury is selling more and more Treasury notes and bonds to cover the deficit. Along with our inability to govern ourselves (see the House of Representatives fiasco), the huge increase in the supply of Treasuries will tend to increase the yield required to sell the ever-increasing quantity of US bonds. Foreign buyers are no longer buying Treasuries at the rate that they have in the past. This means that private citizens, pensions, and financial institutions will have to take up the slack.
Investor focus on the deficit may weigh on markets
The biggest impact of this potential problem is that Treasury rates are used to value all future cash flows in the economy. This will be most visible not only in bond prices but also in stock prices. I don’t believe that we have the political will to address our country’s fiscal deficit. This means that if investors’ focus has shifted from the Fed to the size and growth rate of the deficit then financial assets are in a precarious position.
The term “bond vigilantes” was coined by Ed Yardeni during the Clinton administration. It meant that the bond market could enforce responsible behavior on Congress by raising interest rates to the point that Congress would be compelled to reduce the deficit. One might consider this to be similar to taking away the credit card from someone who had an addiction to spending money. James Carville (a Clinton campaign advisor) went so far as to say that when he died, he wanted to come back as the bond market because it can intimidate anyone.
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