Four is the loneliest number for bonds

By Paul R. La Monica, CNNMoney
2009-6-8 12:23:27

NEW YORK (CNNMoney.com) -- Long-term Treasury bond yields continue to creep toward 4%, a level they haven't traded at since mid-October. And that's raising an interesting "Is the glass half-full or half-empty" type of debate.

Is the recent surge in bond yields merely confirmation that the economy is starting to recover or will the increase in long-term interest rates imperil any chance of an economic rebound?

It probably depends on how much higher bond rates go.

Treasury prices have fallen sharply in the past few months, coinciding with the massive rally in stocks. Bond prices and yields move in opposite directions, so that has pushed rates on the benchmark U.S. 10-year Treasury up to about 3.9%, from a low of 2.04% in mid-December.

If the recession is really nearing an end, it would make sense that bond prices would fall. Investors should be more willing to bet on riskier assets such as stocks in a period of economic expansion and sell some of the bonds they had bought in a proverbial flight to quality rush.

Plus, rates were so low earlier this year due to fears that Citigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500), among others, could be nationalized and that the economy was actually headed into another Depression.

Talkback: Are interest rates too high right now? Leave your comments at the bottom of this story.

So it may not be the case that investors are dumping bonds solely because of hopes of an economic rebound.

"Is the behavior in the Treasury market irrational? Does it represent that people are overly exuberant, or is it an orderly unwinding of the 'My God, the world is coming to an end' trade we had earlier this year? It's hard to disentangle the two," said Chris Probyn, chief economist with State Street Global Advisors in Boston.

What's more, rising yields are often a sign that the bond market is more focused on inflation. And while run-away inflation is something the Fed would like to avoid, a modest pickup in prices is usually associated with an economy on the mend.

Could rising rates kill a recovery?

Still, the spike in bond yields is a significant move in a short period of time. And it's a bit alarming because it has taken place despite the Federal Reserve's best efforts to keep a lid on rising interest rates.

The Fed lowered its key federal funds rate, an overnight bank lending rate, to near zero in December and has kept it there ever since. And the central bank announced in March it would start buying $300 billion in long-term Treasurys to keep long-term rates low, a phenomenon known as "quantitative easing."

	Investment Basic Investment Overview Investment Approache Fundamentals Data Investment Stories www.fxj108.com	Four is the loneliest number for bonds By Paul R. La Monica, CNNMoney 2009-6-8 12:23:27 NEW YORK (CNNMoney.com) -- Long-term Treasury bond yields continue to creep toward 4%, a level they haven't traded at since mid-October. And that's raising an interesting "Is the glass half-full or half-empty" type of debate. Is the recent surge in bond yields merely confirmation that the economy is starting to recover or will the increase in long-term interest rates imperil any chance of an economic rebound? It probably depends on how much higher bond rates go. Treasury prices have fallen sharply in the past few months, coinciding with the massive rally in stocks. Bond prices and yields move in opposite directions, so that has pushed rates on the benchmark U.S. 10-year Treasury up to about 3.9%, from a low of 2.04% in mid-December. If the recession is really nearing an end, it would make sense that bond prices would fall. Investors should be more willing to bet on riskier assets such as stocks in a period of economic expansion and sell some of the bonds they had bought in a proverbial flight to quality rush. Plus, rates were so low earlier this year due to fears that Citigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500), among others, could be nationalized and that the economy was actually headed into another Depression. Talkback: Are interest rates too high right now? Leave your comments at the bottom of this story. So it may not be the case that investors are dumping bonds solely because of hopes of an economic rebound. "Is the behavior in the Treasury market irrational? Does it represent that people are overly exuberant, or is it an orderly unwinding of the 'My God, the world is coming to an end' trade we had earlier this year? It's hard to disentangle the two," said Chris Probyn, chief economist with State Street Global Advisors in Boston. What's more, rising yields are often a sign that the bond market is more focused on inflation. And while run-away inflation is something the Fed would like to avoid, a modest pickup in prices is usually associated with an economy on the mend. Could rising rates kill a recovery? Still, the spike in bond yields is a significant move in a short period of time. And it's a bit alarming because it has taken place despite the Federal Reserve's best efforts to keep a lid on rising interest rates. The Fed lowered its key federal funds rate, an overnight bank lending rate, to near zero in December and has kept it there ever since. And the central bank announced in March it would start buying $300 billion in long-term Treasurys to keep long-term rates low, a phenomenon known as "quantitative easing."