I think very common wisdom prevails at most levels of society. How one articulates that wisdom is often where the message gets lost. So here is something I read recently that seems to do a decent job of describing the inevitability of higher interest rates on US treasury notes and bonds. Allow me to paraphrase from a recent piece by authors Stephen G. Cecchetti, MS Mohanty, and Fabrizio Zampoli, called the future of public debt: prospects and implications.
“The politics of public debt vary by country. In some, seared by unpleasant experience, there is a culture of frugality. In others, however, profligate official spending is commonplace. In recent years, consolidation has been successful on a number of occasions. But fiscal restraint tends to deliver stable debt; rarely does it produce substantial reductions. And most critically, swings from deficits to surpluses have tended to come along with either falling nominal interest rates, rising real growth, or both. Today, interest rates are exceptionally low and the growth outlook for advanced economies are modest at best. This leads us conclude that the question is when the markets will start putting pressure on governments, not if. When, in the absence of fiscal actions, will investors start demanding a much higher compensation for the risk of holding the increasingly large amounts of public debt that authorities are going to issue to finance their extravagant ways?” For the full article: http://www.bis.org/publ/othp09.pdf .
The current zero interest rate policy can hold short rates down forever, however due to the free market method of determining borrowing costs for several years rates are not so easily controlled once stimulus programs and outright government purchases have run their course. The current problem for the Fed is how to divest itself of all the toxic paper they bought. Never mind the longer term issues of unfunded liabilities and inevitable inflation.
Fridays price action saw decent liquidation in June futures, perhaps related to option expiration, the open interest fell over 50K on preliminary reports. Commodity prices are still looking quite strong and the CRB looks poised to move above recent highs made back in April. This tells me that the path of least resistance remains for yields to head towards 4% and beyond, very likely by June. More later.
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