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Treasury Yields Stubbornly Low Despite Year-End Volatility; Uncertainty Reigns

By (Darrell Delamaide/ 22, 2021 04:41AM ET
Treasury Yields Stubbornly Low Despite Year-End Volatility; Uncertainty Reigns
By (Darrell Delamaide/   |  Dec 22, 2021 04:41AM ET
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Inflation is rising, the Federal Reserve is reacting slowly, and yields on the 10-year Treasury remain stubbornly low, fluctuating gently below 1.5%.

US 10-year Treasury Weekly
US 10-year Treasury Weekly

What does this mean?

Analysts are starting to suggest that neither the Fed nor the government are planning to do anything about inflation even as they pay lip service to fighting it. Rather, the plan is to melt down the massive US debt with inflation to make it more manageable.

Investment strategist Rida Morwa this week compared the current situation to the period during and after World War II, reading the signals from Treasury yields as mirroring those from that time. Since budget cuts and higher taxes are politically unpopular, he concludes:

“A significant amount of inflation is the only solution that the US government has to manage its debts and obligations.”

This view goes a long way to explaining why the Fed is stubbornly ignoring the rise in inflation—no longer pretending it is transitory in the sense of temporary—and dragging its feet in tightening monetary policy. It also explains why the administration is blithely planning to spend trillions of dollars after the trillions already spent to counter COVID-19.

Bond Investors Tread Carefully; Recession Possibility Looming

Alternatively, many analysts are thinking low Treasury yields signal a recession, or at least a severe slowdown in growth. This could lead to lower inflation and be a reason for yields to remain low.

Pick your poison.

What nobody questions is that the pandemic and the governments’ response to the coronavirus has created a situation without historical precedent. A cautious investor would certainly tread carefully in such an environment.

Yield on the 10-year benchmark reflects this caution. After crashing to near 0.5% with the onset of COVID-19, the yield spiked briefly above 1.75% early in the year, buoyed by optimism about vaccines before inflation reared its head. Since then, it has rarely cracked 1.5%.

Compared to the near 4% in the wake of the financial crisis or above 3% in late 2018, this is hardly an encouraging sign. With inflation likely to persist well above 2% into next year and beyond, the prospect of negative real interest rates continuing is causing a lot of concern.

Trading will be thin in the last two weeks of the year. Bond markets will close early on Thursday and stay closed on Friday to observe the Christmas holiday. This will exacerbate the volatility of the past few weeks, as investors weigh the tightening of monetary policy against the new wave of infections from the Omicron variant.

It is perhaps a fitting close to a turbulent year marked by bouts of uncertainty. Equities have been on a roller coaster but climbing steadily and hitting record highs while Treasury yields have stayed in a narrower band.

Central banks have largely ignored inflation until the last few weeks, and investors have taken their cue from them. Increasingly, however, it is difficult to ignore the impact of the massive liquidity injection from central bank asset purchases. You don’t have to be a monetarist to wonder if things have gone too far.

Treasury Yields Stubbornly Low Despite Year-End Volatility; Uncertainty Reigns

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Treasury Yields Stubbornly Low Despite Year-End Volatility; Uncertainty Reigns

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