Monday, June 4, 2012
Fed Policy Drives Bond Yields Lower
Last week David Rosenberg provided an array of charts portraying his views on the global economy and financial markets. Rosenberg, in my view, has been one of the most accurate forecasters the past several years and really nailed the continuing disinflation trend. One chart that stood out and I felt worth showing is the above correlation between bond yields and Fed policy.
On several occasions in the past couple years I’ve tried to explain that Treasury yields are simply a function of the average expected Fed Funds rate over the duration of the bond. As expectations for the Fed to maintain near-zero rates are extended into the future, this average continues to fall and yields have followed in due course. Many analysts and investors have missed the big move in yields because they failed to recognize this relationship and instead focused on negative real yields, QE, large government deficits and declining interest from abroad.
US households remain over-leveraged and the continued efforts to reduce debt makes sustained high inflation improbable without massive government stimulus. A deflationary environment in Europe and potential hard landings in BRIC countries will also keep the Fed on hold for several years to come. Potential gains from investing in long-duration Treasuries are growing slim, but it should not surprise anyone to see yields move even lower from here.
Permanent Zero: Record Low Treasury Yields and Banking Instability
Treasury Yields Low for Good Reason