Obama-GOP deal and QE2 drive up Treasury yields
Treasury yields climb as inflation expectations rise: the nominal yield has climbed 65 basis points in three months, implying 2.3 percent inflation over the next 10 years.
Between Fed Chair Ben Bernanke's second round of quantitative easing ('QE2') and President Obama's new deal with the GOP to cut taxes, increasing numbers of economists are expecting inflation to rise. Here, Dr. Bernanke (l.) speaks to the press alongside Mr. Obama in 2009 in Martha's Vinyard, Mass., after being nominated by Obama for a second term as chairman of the Federal Reserve.
Jason Reed / Reuters / File
As I noted yesterday, the tax and spending deal between Obama and the Republicans have caused a significant increase in the yields of long-term U.S. Treasury securities. If you combine yesterday's and today's increases, we have a combined 30 basis point increase. Judging by the movements of the inflation-indexed securities, roughly half of that increase reflects higher real interest rates and half reflects higher inflationary expectations.
What few had noticed moreover, was that even before the deal, nominal yields had actually risen above the level before the Fed started to warn about QE2. By contrast, real yields was, and remains despite the last two days, below the levels before QE2.
So the real story is about how inflationary expectations have increased dramatically. For 10-year securities, the nominal yield is nearly 65 basis points above the level in early September while the inflation indexed yield is 10 basis points lower, implying an increase in inflationary expectations of 75 basis points. The implied 10-year inflationary expectation is roughly 2.3% now.
For 5-year securities, the nominal yield is about 45 basis points above the level in early September, while the inflation indexed yield is about 20 basis points lower, implying an increase in inflationary expectations of 65 basis points. The implied 5-year inflationary expectation is roughly 1.85% now.(For current values see here, for historical values see here).
So, if the purpose of QE2 was to increase inflationary expectations, it has certainly succeeded, aided in part by the tax-and spending deal. If however the plan was to lower nominal interest rates, then it has certainly failed, in part because of the effects of the tax- and spending deal.
Another thing to note about the big increase in interest rates is that it to the extent it reflects higher real interest rates is bearish for gold (and silver) as it increases the opportunity cost of holding gold (and silver).
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