Tuesday, September 20, 2011

How low can Treasuries go?

You can go out five years with Treasury rates below 1%. Still, Treasuries have a steep yield curve with a differential of over 320 bps between 3-months and 30 years. No inversion of the yield curve to signal recession but the low yields suggest that trend growth is going to be very low. If we play the trend growth is equal to real rates game, the 30 year bond is suggesting no inflation for the next 30 years. This is highly unlikely given the current inflation rate ex food and energy is at 2% (3.5%  for headline CPI). If we place an inflation rate of 2%, then the trend growth has to be close to zero for the 10-year and only about 1 percent for the 30-year. There s going to to be at least one lost generation maybe 2-3.

The markets are not thinking that the Fed will inflate itself out of the problem. The short-term thesis is that we will have Operation Twist redux with a major purchase of 30-year bonds by the Fed. There is not a lot of risk premium in these bond numbers. 

So, do we use Japan as the benchmark for the US Treasury yield direction? It looks like this is a good example of what may be in store for the fixed income markets, but the US is still not Japan. Or is it?

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