(February 9) – “The Treasury bond market went haywire last week. What exactly does the chaos in this huge and hugely significant market mean to investors? ,” asks Gretchen Morgenson in today’s New York Times.
“The turmoil hit traders hardest at the nation’s banks, brokerage firms and hedge funds. Many of these players had bet — accurately — that the Federal Reserve Board would raise interest rates. Normally, such a move would push up yields on both short-term and long-term securities.
“Not this time. Even as the Fed voted to raise short-term rates by one-quarter point, yields on long-term Treasuries declined, from 6.48 percent on Monday to 6.26 percent on Friday. Two-year Treasury notes ended the week at 6.61 percent.
“It isn’t often that short-term rates are a good deal higher than longer-term rates. And when it happens, it traditionally portends an economic slowdown. That is in large part because financial institutions — which borrow at short-term rates and lend long — have no incentive to make loans in such an environment. If credit is tight, companies cannot finance their growth and economic output declines.
“Almost nobody thinks that last week’s bond market action is pointing to a slowdown. Indeed, all the data point to a blazing economy, which is why the Fed feels compelled to raise rates.
“Rather, traders say, the bond market is embroiled in a technical move unrelated to economic fundamentals. Lower yields on long-term bonds are a direct result, they say, of the Treasury’s plan to both reduce the amount of debt it will issue and to buy back many existing bonds. With the Treasury focusing its aim on securities with 10- to 30-year durations, investors made a mad scramble to buy long-term bonds ahead of a shortage.
“This widely held view worries Andrew S. Teufel, research director at Fisher Investments Inc. in Woodside, Calif. While he agrees that the Treasury refinancing plan is having a huge impact on the bond market, he is troubled by the idea that everyone is writing off the interest rate inversion as merely technical. He wonders if the market is indeed trying to send investors a warning — one that is being ignored.
“It is too soon to tell whether the bond market is signaling a slowdown. But the rise in short-term rates is hurting shares in financial institutions, whose borrowing costs are increasing.