Short View: Bond market
By John Authers, Investment Editor
Published: May 28 2009 19:04 | Last updated: May 28 2009 19:04
Is the bond market the great stabiliser of the world economy or the territory of vigilantes determined to extract a price for governmental profligacy?
Either reading of the sharp rise in 10-year Treasury bond yields and in mortgage rates, only partially reversed on Thursday, is possible.
The 10-year yield, at about 3.7 per cent, is far below the 5 per cent it hit two years ago, when a bond scare triggered the credit crisis. By historical standards, yields are very low, consistent with a trend that has persisted for a quarter of a century. They are not high enough to derail an economic revival.
A rise in yields, barely 2 per cent when the US Federal Reserve unveiled its plan to buy bonds, could be an overdue return to normality. Investors are no longer making flights to safety and are selling bonds.
It can also be argued that bond yields will not rise enough to halt recovery. If they did, growth would fall and people would buy bonds, pushing yields down.
Yet there is another view, also rooted in common sense. The global economy came out of its freefall thanks to the spending of piles of government money. That must be financed. The bond market could prove to be a crucial bottleneck.
Mortgage rates are critical. They need to stay at artificially low levels, not at historical norms, if the plan to revive US housing and banks’ balance sheets is to work.
Mortgage rates had stayed low only thanks to historically low spreads compared with Treasuries. They have now snapped. The latest US mortgage delinquency figures are horrendous, with more than 6 per cent of prime mortgages in arrears – more than double the long-term norm. A quarter of subprime loans are delinquent.
Even if the bond market is merely normalising, vigilantes could have no effect. The US needs bond yields to be much less than normal for a while.