The level of rates is something that has greatly concerned me for the last 6-9 months. Given the economy is growing by 4% and the increase in short-term rates last year (a full 100 bp or 1%), rates should be higher. But, capital is still relatively cheap.
The argument for higher yields - and thus lower bond prices - is compelling. Growth is strong, employment apparently firming, the economy is awash with liquidity and inflation has not disappeared for ever. Mr Greenspan recently warned that anyone doubting the Fed's intention to continue raising rates must want to lose money. Fiscal discipline is absent. Higher trend productivity growth eventually implies a higher long-term real interest rate. Moreover, the US ultimately will have to offer global investors higher interest rates to continue to attract foreign capital to finance its giant current account deficit. But this was the case at the start of last year as well.
Why then did yields not rise? Higher oil prices were seen as a tax on growth, not inflationary. Asian central banks bought huge quantities of Treasuries to hold down exchange rates. But this is not the whole story. A Fed study suggests central bank buying might be worth up to 50 basis points. As importantly, there was no competition for capital from companies flush with cash and seeking to repair balance sheets.
Some or all of these factors will probably reverse this year. In the longer term, higher yields look inescapable as part of the required rebalancing of the US economy. But the bond market is also telling us that risks are skewed to the downside, that the economy remains fragile due to high debt and other imbalances. Alongside the most likely case of continued expansion and considerably higher yields is a not- insignificant possibility of relapse.
An inherent assumption I have been making is the bond market is ready for a sell-off. But that hasn't really happened.
This article makes an incredibly valid point. Maybe rates haven't increased because the bond market knows the economy isn't as good as the macro-numbers suggest.
http://news.ft.com/cms/s/1924e95a-611a-11d9-af5a-00000e2511c8.html