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Treasury-security Yields Continue Their Sharp Fall [Updated]

A Zero-Interest Rate World

The 30-year T bond is priced to yield 3.34% this morning. The 10-year note is at 2.83%. These are extraordinary numbers, and they’re still falling fast. Three-and-six month bills are already at or near zero. This is powerful and continuing evidence that markets are uncertain and fleeing from risk.

The midcurve and long-end are multi-trillion dollar asset classes that have increased in value by something like a third, in just the last few weeks. If you thought supertankers couldn’t turn on a dime, you haven’t been watching the bond market.

One is also tempted to say this is evidence that markets are expecting extreme economic weakness ahead.

But there are so many dislocations in the bond market and trading is so illiquid, that it would be a stretch to say this is signaling anything but total uncertainty. By “dislocation,” I mean that there is an abundance of relationships among assets that make no economic sense. (The continuing negative 30-year swap spread is just one example.)

A textbook world would arbitrage the dislocations away almost immediately. Yet they persist and in some cases are growing.

But what is the real price of money in a time of deflation? A zero-yield six-month Treasury bill, combined with October’s 1% decline in CPI, implies a real interest rate of something like 5 or 6%: that’s exceptionally high, and a very good reason not to engage in economic activity.

Then there is the pricing of TIPS. These are Treasury securities that adjust their principal amount every year according to the Consumer Price Index. So in theory, they represent the real cost of risk-free money at any given point on the yield curve. And the difference between TIPS yields and Treasury yields predicts future inflation.

As far as I can tell, the current TIPS spread appears to be predicting that we’ll have deflation of more than one percent each year for at least the next five years. Make of that what you will.

As I said, extreme uncertainty. And uncertainty breeds risk-aversion, which breeds economic weakness.

Update: At 10am ET, the 30-year bond is up almost two and 26/32, to yield 3.30%. The 10-year note is yielding 2.81%. As I said, extraordinary.

-Francis Cianfrocca

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