U.S. Treasuries bounced up on Tuesday after a major selloff during the two previous trading sessions had put the effectiveness of the Federal Reserve's economic stimulus plan in question.
With stock markets hit Tuesday by renewed sovereign debt fears in Europe and worries that China would raise interest rates in an attempt to cool its economic growth, traders moved money from equities and commodities into more secure assets that included Treasuries.
As buyers moved in, the yield on the benchmark 10-year Treasury notes fell 10 basis points to 2.86 per cent. In the two prior days of trading, the yield had risen 31 basis points. The yield on 30-year notes followed a similar pattern. (Bond prices and yields move in opposite directions).
Rising yields are problematic for the Fed and its chairman Ben Bernanke because the U.S. central bank is trying to push down longer-term interest rates to encourage business and consumer spending through its controversial plan to spend $600-billion (U.S.) to buy government bonds. The latest round of "quantitative easing" is designed to increase demand for Treasuries, thereby reducing their yields.
But the price of Treasuries fell last Friday and Monday by the largest amount in almost two years, leading market experts to sound the alarm on the Fed's plan to boost the economy.
"To the extent that the backup in Treasury rates reflects better-than-expected economic data and a diminished risk of recession, then the Fed can rest somewhat easy. But if the backup reflects growing concern about U.S. sovereign risk, as highlighted by the situation in Ireland [and]Greece and the [municipal]bond market, then Houston, we have a problem." Sal Guatieri, senior economist at BMO Nesbitt Burns, said in a report.
Analysts have offered numerous explanations for why the bond market is reacting erratically to the Fed's move, including the possibility that the selloff has been nothing more than investors cashing in their profits after riding a rally that began early in the year. Additionally, there has been a strong flow of high-quality corporate bond issues in recent weeks, which may be attracting dollars away from Treasuries.
There have also been some positive economic signs in the last few days that may have left investors more bullish on the recovery. Retail sales in the U.S., for example, climbed back last month to levels not seen since before the collapse of Lehman Brothers in September, 2008.
"The fact that Treasury yields have risen rather than fallen since the Fed announced the launch of QE2 is not necessarily evidence that the policy is failing," noted Julian Jessop, chief international economist at London-based research firm Capital Economics. "However, it does underline our concerns that additional monetary easing may not provide much help to the wider economy and could simply encourage the development of new bubbles, notably in commodities, that ultimately self-destruct."
He also noted that yields are still well below the levels they were in the summer before the Fed signalled, given the lacklustre state of the recovery, that further quantitative easing was likely. Additionally, if yields are in fact rising because investors are more confident now about the outlook, then the results could still be positive, he wrote.
Mr. Jessop expects the yield on 10-year Treasuries to average 2.5 per cent next year.