US stimulus plans becoming difficult as bond yields rise

There has been a huge rally in bond yields in the last few weeks. This will make the stimulus plans being initiated by the US Treasury and Federal Reserve more difficult (it will be even worse for other countries with weaker credit, such as Britain.) Perhaps the biggest impact of rising yields will be on the housing market (since mortgage rates will rise.) The corporate sector will also be impacted but so far things look good, with big appetite for junk bonds during the recent rally.

It'll be interesting to see what comes of all this. I personally have no idea if the bond sell-off is simply due to the improving economy (bonds are less attractive if economy is strong) or if it is due to bond investors signalling their displeasure with government policies (and potential for higher inflation.) Bloomberg has an article on the return of the bond vigilantes:

For the first time since another Democrat occupied the White House, investors from Beijing to Zurich are challenging a president’s attempts to revive the economy with record deficit spending. Fifteen years after forcing Bill Clinton to abandon his own stimulus plans, the so-called bond vigilantes are punishing Barack Obama for quadrupling the budget shortfall to $1.85 trillion. By driving up yields on U.S. debt, they are also threatening to derail Federal Reserve Chairman Ben S. Bernanke’s efforts to cut borrowing costs for businesses and consumers.

The 1.5-percentage-point rise in 10-year Treasury yields this year pushed interest rates on 30-year fixed mortgages to above 5 percent for the first time since before Bernanke announced on March 18 that the central bank would start printing money to buy financial assets. Treasuries have lost 5.1 percent in their worst annual start since Merrill Lynch & Co. began its Treasury Master Index in 1977.

“The bond-market vigilantes are up in arms over the outlook for the federal deficit,” said Edward Yardeni, who coined the term in 1984 to describe investors who protest monetary or fiscal policies they consider inflationary by selling bonds. He now heads Yardeni Research Inc. in Great Neck, New York.


4 Response to US stimulus plans becoming difficult as bond yields rise

John Y
May 31, 2009 at 10:46 PM

I'm always puzzled by the casual relationship between bond yields and interest rates. My naive understanding is the Fed rate is the one and only one controllable parameter which will influence the demand of borrowings and, thus, indirectly the mortgage rates.
What is the underlying mechanism that bond yields will affect mortgage rates? And what is the relationship between Fed rate and bond yields?

June 1, 2009 at 10:37 AM

I'm not an expert on it but I think what you said is incorrect, sort of.
Mortgage rates are influenced by long-term rates (such as the 10 year and 30 year bond yields).
The FedRes generally only controls the short-term rate. Influencing the short-term rate is supposed to impact the long term rate but it is not always predictable (for example, the FedRes was raising rates from 2006 to 2007(?) but the long term bond yields did not move--this is when Bernanke came up with the Savings Glut theory to explain it, while others were saying it was due to foreign central banks undertaking uneconomic decisions.)
You can see how the short term rate doesn't impact things like mortgages by observing the present situation and how the short-term rate is close to zero yet mortgage rates are much higher (slightly above long-term bond yields). If long term bond yields rise, it should increase mortgage rates.
Having said all that, I think the short-term rates, which are controlled by the FedRes, do impact other things like credit card rates, maybe auto loans, and the like. Some of these are influenced by LIBOR, which in return is heavily influenced by short-term rates.

June 5, 2009 at 12:57 PM

The chart in this post from Calculated Risk nicely shows the high correlation between mortgage rates and 10 year yields. So, it's the long term yields that really matter.

June 7, 2009 at 9:03 PM

great article...the charts are good too...

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