The rate at which investors are willing to lend the U.S. government money for ten years just reached a new near-term low on May 31, 2012. Financial commentators were calling it “mesmerizing.” How could so many people be so willing to lend money for so long and be paid so little for it?
What Is the US Treasury Yield?
The US Treasury is a bond. It represents an “IOU” from the government to whomever buys it. It basically says that the government will pay you back the principal (=the original amount of the bond) PLUS the yearly interest it accrues (the YIELD).
So if you buy a $100 ten-year Treasury, you are lending the government $100 for ten years. And at this recent rate (it will fluctuate a bit continuously), you will be paid just $1.53 each year for doing so.
Why Are 10-Year Yields So Low?
So why are the yields on the 10-year US Treasury so low right now? Well, in general, yields on bonds drop when bond prices go up. When there are a lot of people wanting to buy the bond, there is less need for a higher yield (yields are used to attract investor interest in the bond offering).
More investor demand = higher bond prices and lower bond yields.
So the question becomes why do so many investors want to buy the 10-year note? Why do so many people want to buy US debt when the US can print as much paper money as it wants? The US debt-to-GDP ratio is nearly 100% and it’s getting worse daily. Spain’s debt-to-GDP is better than that of the US. Capeche?
Bet On Massive Inflation
Simply put, investors are saying that US debt levels don’t matter. When yields keep sinking it means more and more money is pouring in, offering itself up to the alter of Bernanke’s proverbial printing machine. Investors are placing relative confidence (relative to all the other places they could put their money) in the US Federal Reserve.
As one of my Twitter colleagues put it, never bet against the government – because they can change the legislation, and you can’t.
Another reason, more practical, investors are throwing money into the Bernanke fire is how liquid the huge US debt pool has become. There is more US debt floating around in the world than arguably any other asset class. Is it really any wonder it is the most liquid?
What all this means is that inflation is going to continue. Some regions are able to keep pace with it – the oil-rich province of Alberta in Canada just raised the minimum wage level for the second time in 18 months – others, not so much. (The best reason to buy gold).
And with further slowdown in the world economy, analysts are speculating on another round of quantitative easing by Bernanke later in the year. Money is going in one direction only, folks! (German Bund yields are also falling fast.)
Ironically, some take the low rates to be an indication that investors are NOT afraid of inflation happening (reasoning that if inflation were expected, they would be seeking higher returns from the government). But that argument doesn’t make sense to me. They would find higher yields elsewhere. It’s pretty clear that inflation comes from the devaluation of the currency (aka “money printing”).
The Future of the 10-Year Treasury
So what’s next? How low will the 10-Yr yield go? The lower it goes, in my books, the more likely it is that more people are perceiving continued risk globally and see the US as the lesser of the evils (even though there is a good argument about how risky US debt is).
If the yield rises too much, on the other hand, or very quickly, it is potentially quite dangerous, as it becomes more expensive for the US to meet its obligations – and we know where that road would lead.
So everyone should actually want and HOPE FOR lower yields on Treasurys. In that respect, they are not surprising at all. But the downward progression of the yield does have negative side effects – lower yields hurt savers, seniors, anyone relying on fixed income from their investments. And they do push investors who need that yield into riskier, higher-yield territory elsewhere.-