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The 10-Year Treasury Yield Dilemma

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The US may be the least risky investment out there.

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Today's spike in 10-year Treasury yields (TNX) towards the 4.00% level has got my attention. I have consistently pointed to weakness in the Treasury market as the biggest risk to the current rally.

In my view, this increase in long-dated yields does not signal a serious loss of faith in the credit of the US Treasury, nor does it signal any sort of serious future inflation. Rather, this increase in yield is a function of a technical supply and demand phenomenon – plain and simple.

Notwithstanding much jawboning to the contrary, the problem is not so much that the relative credit standing of the US has deteriorated, but that global supply of sovereign debt securities has exploded. We live in a world in which virtually every government is increasing fiscal deficits and needs to finance them just like the US does. The problem of government debt supply is not just a US problem; it's global. Thus, there's global competition among sovereigns for capital. And the fact that non-government fixed-income yields are so juicy at the moment just adds to the dilemma on the supply side.

The idea that the increase in yields is more a function of technical supply and demand than economic fundamentals is supported by looking at the yield curve which is only modestly steeper than previous recent peaks. The relatively small difference between this and previous peaks can easily be explained by the supply/demand factor and the severity and synchronous nature of global budget deficits at this particular juncture.

On the other hand, in the short term, the fundamental considerations above are of less importance than the perception that Treasury yields above 4.00% could put a dent in the recovery.

I have mentioned that for this reason, a 10-year yield considerably above 4.00% would trigger a stop for me. Looking at the charts, that level should be about 4.25%. We could get there very quickly, so I am watching developments closely.
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