It's a bond rout.
On Dec. 8, prices for U.S. Treasurys plunged and yields on the benchmark 10-year U.S. Treasury hit a six-month high of 3.33%. That's a full percentage point higher than the October low. And it's a shocking 0.76 percentage point above the yield just a month ago on Nov. 8.
It's not just happening to U.S. Treasurys. Bond prices are plunging and yields soaring for developed-economy bonds across the globe. In that same one-month period, yields on German 10-year bonds are up 0.62 percentage point, yields on 10-year U.K. bonds are up 0.53 percentage point, and yields on Japanese 10-year bonds are up 0.29 percentage point.
Let's start with the why of this big bond market move, then move to the why you should care.
What ails the bond market
The reasons for the move up in yields -- and down on prices -- on U.S. Treasury bonds are pretty simple.First, the fundamentals. The Federal Reserve is dumping an additional $600 billion in cash on the U.S. economy through its program of Treasury buying. The proposed package for extending the Bush administration tax cuts would throw an additional $1 trillion at the economy. Even though these aren't particularly efficient forms of stimulus, that much money will increase U.S. economic growth.
On Dec. 9, Pacific Investment Management or Pimco, which manages the world's largest bond fund, raised its growth forecast for the U.S. economy in 2011 to 3% to 3.5%. That's up from a previous forecast of 2% to 2.5% for the year.
Increased economic growth usually leads to more inflation. And if inflation is going up, bond buyers want a higher yield before they buy -- to balance out the larger bite that inflation will take out of their interest payments and capital. And if yields are to go up, bond prices must go down.
Second, the psychology.
The proposal from the Obama White House and Congressional Republicans to add $1 trillion in debt over the next two years to the U.S. balance sheet by extending the Bush tax cuts has just put a capstone to the feeling that the U.S. government doesn't have an inkling of a plan for dealing with the U.S. deficit. And worse, because most bond investors were convinced of that before the deal was announced, the markets now believe that nobody in Washington cares. Take the heat to restore fiscal sanity? You can hear the laughter all the way out to the Lincoln Memorial. (See my post on the proposed deal, "Wall Street economists score the tax deal: $1 trillion in costs to get 0.5% increase in GDP growth in 2011.")
Why would anyone want to buy U.S. Treasurys when the United States seems committed to fiscal irresponsibility, a debased currency and as much inflation as necessary to make the huge U.S. debt load as easy to repay as possible?
None of this means that Treasury prices are about to fall off a cliff or that U.S. interest rates are about to zoom to 5% on the 10-year Treasury. The most recent bull market in Treasurys lasted 25 years, and there's no reason to think that a bear market in Treasurys wouldn't take that long to unfold.
The current rout doesn't mean there won't be up days -- Treasury prices rallied slightly on Dec. 9, for example, before falling again on Dec. 10. There's enough worry about bonds from other countries to make Treasurys look like a real bargain on some days. It wouldn't take much of an increase in the temperature of the euro debt crisis to send money out of German bonds and into the seeming safety of Treasurys. (For an example of how volatile bond markets can be, see my post "Relief rally takes hold ahead of the European Central Bank meeting; will the bank rain cash on the markets?")
But I think you can count on the trend now moving toward higher interest rates in the United States no matter what the Federal Reserve does to the short-term rates that are currently locked near zero. Short of a double-dip recession, all that's uncertain is the speed with which bond prices will fall and interest rates will rise.
Continued: Why you should care
