The U.S. Treasury plans to sell $118-billion (U.S.) in two-year, five-year and seven-year notes next week at a time when several state governments are under acute financial stress, according to Action Economics LLC. Are “bond vigilantes set to roar in 2010?,” it asks in a report to clients.
That term refers to the possibility that bond buyers might force yields up before they are willing to buy U.S. Treasuries.
But at least for now, bond markets appear to be taking next week's auctions in stride. The yield on two to 30-year bonds only rose between two and four basis points this week, (A basis point is 1/100th. of a percentage point).
However, during the past month, the yields on two-year, 10-year and 30-year U.S. Treasuries have increased by 21 basis points, 46 points and 39 points, respectively, to 0.94 per cent, 3.76 per cent and 4.64 per cent.
The main impetus for higher rates in 2010 is the approximately $2-trillion in new Treasury supply that is slated to hit the market in the next 12 months. — Jack Adkins, Action Economics
The auctions consist of $44-billion in two-year notes on Monday, $42-billion in five-year debt on Tuesday and $32-billion in seven-year debt on Wednesday.
“Looking ahead to 2010, a cautious consensus has emerged that Treasury yields should rise next year, but the expected rise in yields is unlikely to damage or derail the fledgling economic recovery,” said Jack Adkins, a director of quantitative strategy, North America, for Action Economics LLC. in a report to clients.
“The main impetus for higher rates [for long-term bonds] in 2010 is the approximately $2-trillion in new Treasury supply that is slated to hit the market in the next 12 months,” he said.
Technical analysis suggests that yield on 10-year notes could rise well above the current range of 4.5 to 4.75 per cent, he said. Technical indicators suggest a potential target of a 5.7 per cent rate in 2010, he said.
Among the triggers for a possible unexpected rise in interest rates is the financial distress of several U.S. state governments leading fixed-income traders to re-price sovereign risk, according to Action Economics.
California Governor Arnold Schwarzenegger
Today, Bloomberg News reported that California Governor Arnold Schwarzenegger plans to seek federal aid from President Barack Obama as the state struggles with a $21-billion budget deficit.
Among the other state budgets under stress are New York, Connecticut, North Carolina, Indiana, Ohio and New Jersey, according to Action Economics.
“This hints that a large component of the rise in yields in the long end of the curve will come as Treasuries are forced to ‘compete' with riskier assets for bidders in order to place the massive [bond] supply,” Mr. Adkins said. That could result in sovereign interest rates rising against corporate bonds, he said.
Others are looking for the U.S. Federal Reserve Board to begin raising interest rates.
“With the economy gaining momentum into 2010 and the labour market showing signs of stabilization, we think the Fed will have to take advantage of its first window to raise its policy rate – the rate setting meeting of April 27-28,” said Paul-André Pinsonnault, senior fixed-income economist with National Bank Financial Inc.
