Two Possible Reasons for the Rise in 10-Year Treasury Notes

Somehow, we don’t think this is what Ben Bernanke had in mind when he launched another round of easy money five weeks ago.

Indeed, he promised us lower long-term interest rates. But this morning, the yield on a 10-year Treasury note just reached its highest level in more than six months – 3.28%.

Highest Yields of 10-Year Treasury Notes Since May

There are two possible explanations…the benign one, and the more likely one.

The benign one, pimped by Deutsche Bank, zeroes in on the cut in payroll tax that’s part of the Grand Bargain between President Obama and congressional Republicans. Deutsche figures that’ll add 0.7% to GDP during the next two years.

The more likely one is evident even to the always-late-to-the party analysts at Moody’s and Fitch: The Grand Bargain is just digging Uncle Sam into a bigger hole.

The rating agencies reckon that with no spending cuts as part of the deal, it’ll add another $1 trillion to the national debt – above and beyond what’s already baked into the cake.

Treasury plans to auction $21 billion in 10-year notes today. Could be interesting.

But really, should anyone be surprised? After Bernanke launched the first round of “quantitative easing” in March 2009, the rate on the 10-year spiked from 2.5% to over 4% within three months.

Our call: Look for 4% by early February. But we’ll go a step further.

“Every streak must come to an end,” says our income-investing specialist Jim Nelson. “On Nov. 17, that truism hit home in the bond fund world. It was the first week in the previous 100 that saw a net outflow of money.

“Investors, after nearly two years of manic consumption, are finally leery over the future of bonds.”

Net Flows into Bond Funds

That outflow continued in the week ending December 1, according to a report from EPFR Global analysts. Few sectors were spared…

  • Global bond funds suffered their second outflow in 3 weeks
  • Redemptions on high-yield funds hit a 6-month-high
  • Emerging-market bond funds saw 2 consecutive weeks of outflows for the first time since April 2009.

There’s no shortage of reasons, Jim says. “Start with QE2…then add Ireland’s new massive bailout…throw in the new permanent bailout fund for the eurozone. And what do you get? Panicked and confused investors.

“Now, that’s not to say they won’t forget about this in another couple of days and pile right back into bond funds. But if this is a true turning point, we might soon see some discount opportunities – something we haven’t had in quite a while.

“But,” Jim reminded his Lifetime Income Report readers recently, “even as the rest of the world struggles with tough issues, we still find ourselves in a pretty good place. We have a number of solid, undervalued plays that have plenty of capital and growing dividends.”

Ah, dividends. That’s going to be the key for income investors if the 28-year bull market in bonds is really over. Say this much for the Obama-GOP Grand Bargain: It leaves the tax rate on dividend income alone, at least for two more years.

Addison Wiggin
for The Daily Reckoning

The Daily Reckoning