Tom Sowanick is Co-President and Chief Investment Officer of Ominvest Group in Princeton Junction, N.J.
Since June 15, there has been a significant rise in Treasury yields. Below we present several reasons for the spike and why we think that interest rates will continue to move higher.
1. Inflationary pressures globally have forced Central Banks to raise interest rates. The European Central Bank (ECB) will likely raise interest rates to 1.50 percent from 1.25 percent at their meeting on July 7. On a year-over-year basis, US inflation has risen from 2 percent to 3.6 percent.
2. There remains a high level of uncertainty about how the Treasury market will perform now that the second round of quantitative easing (QE2) has officially ended. The Federal Reserve will not be expanding its balance sheet by purchasing additional Treasury notes.
3. Debt problems in Europe appear to be crossing the ocean to the US as investors and rating agencies are becoming more focused on the debt ceiling issue in Washington. The deadline to address this issue is fast approaching (August 2).
4. The very real threat of US credit downgrades and possible default.
5. Asset allocation shifts from bonds into stocks due to a shift in risk appetite and a shift in inflation expectations that favor stocks over fixed-coupon securities.
6. A typically positive seasonal period for equities is still ahead of us - July, August and September.
7. Real interest rates in the US Treasury market are negative which means that investors have been willing to lend to the government, while their investment cannot keep up with increasing inflation.
8. PIMCO and Blackrock, the largest fixed income asset managers in the industry, believe that investors should be out of Treasuries at this point and further believe that stocks will broadly outperform bonds going forward.
These factors occurring in synch have already had a negative impact on the Treasury bond market. At the same time, Federal Reserve Chairman Ben Bernanke continues to echo his view that inflation in the US is “transitory” and will therefore keep interest rates at ultra-low levels for a continued “considerable period of time.”
Translation: investors will sell Treasuries before the Fed begins to raise interest rates, a trend that has clearly already begun.