The action in the bond market is going the wrong way — that’s the wrong way from what most bond investors had expected.
What am I talking about? Billions of dollars are invested each day in U.S. Treasury Notes, the most popular long-term bonds being the U.S. 30-year T-bond and the U.S. 10-year T-bond. With the billions of dollars going in and out of bonds, the market and investors in bonds are basically placing their bets on the future direction of interest rates.
If bond prices rise, it means the market and investors expect lower interest rates ahead. Conversely, falling bond prices can be interpreted as a signal that interest rates will rise in the future.
Where are we today? U.S. 10-year T-bonds hit a new three- month high yield of 4.32% yesterday. The bond crowd, who seemed to be betting that interest rates would not rise much, is now changing its tune. The short-term action in the bond market is indicative of higher interest rates ahead.
Yes, we all know Greenspan will spike the Federal Funds Rate another quarter-point at his next meeting. But the million-dollar question on everyone’s mind is this: Does the action in the bond market now indicate that the Fed will have to raise interest rates much higher than was expected?
If there was a book title on the current U.S. economic environment, I guess you could call it, “Blame It on the Dollar.” But in this simple economist’s mind, the real story is that of the Fed’s tight-rope act, where it is trying to lower the value of the American dollar gently against other world currencies while still keeping foreigners interested in buying our debt instruments. And if higher interest rates will keep investors in U.S. debt instruments, then so be it.
But don’t be fooled about predictions of drastically higher interest rates ahead. The bond market is easing down, not crashing down. Higher U.S. interest rates would put a proverbial knife in the fragile U.S. economy, causing consumers to abort spending… something the Fed definitely doesn’t want.
So what is the action in the U.S. bond market telling us now? It’s telling us interest rates will continue gradually moving up.