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A Blessing of Higher Interest Rates?

Since April 2012 the 10 year treasury yield has been below 2%.  This yield has sustained for months even though the market has been showing a 10 year break-even inflation rate of about 2.5%.  Treasury investors have been locking in negative real yields without a second hesitation.  With the recent decline in treasury prices, we are about to poke our heads above 2% for the first time in about 9 months:

Could we be looking at a new trading range for the 10Y?

Why should you hope for higher interest rates?

  1. The federal reserve might acknowledge that the market no longer reacts to its stimulus, thereby shortening the Fed’s market meddling (unlikely)
  2. Investors in fixed income (seniors/retirees, pension funds, insurance companies) will no longer be bled through an inflation tax
  3. Investors will no longer be incentivized to make bad investments by seeking ever increasingly risky projects (market bubble 3.0)
  4. Any institution with long dated liabilities (pension funds) will see the value of those liabilities decrease as the discounting rate on those cash flows increases

Unfortunately, a large increase in interest rates is probably unlikely until A) the Fed stops or B) the market loses faith in the US government’s capacity to pay its debts.  A) won’t happen because the Fed is full of conviction and B) probably won’t happen because Japan has been getting away with deficit murder for far longer.

The contrarian indicator to this hopeful market breakout is the fact that treasury put volume has hit its second highest level *ever*.  Second only to June 2007:


I would hate to see where interest rates go if this is a predictive indicator…

Posted in Markets.

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