Interest Rate Roundup

Saturday, July 07, 2007

CNBC stint on Monday

Sorry I was out of pocket yesterday, blogwise. I had a lot of things to get wrapped up for the week. But clearly, Friday's decent employment data helped pressure bond prices lower and interest rates higher, as I was expecting. The key now is whether we can break to new price lows and yield highs in the Treasury market -- and hold them.

If you happen to be up early on Monday, I'll be giving my take on the latest bond market action on CNBC's Squawk Box at 6:20 EST. As a sneak peek, I think four general forces are working to drive interest rates higher:

1) Rising foreign interest rates -- The European Central Bank kept its benchmark rate at 4% a couple of days ago, but signaled another hike is coming later this year, probably in September or October. The Bank of England just raised interest rates for the fifth time in less than a year to 5.75%. And other central banks, such as those in New Zealand and Australia, have also been tightening rates. So have policymakers in high-growth countries like China and India.

2) Strong economic data around the world -- Speaking of high growth, retail sales are rising at the fastest pace in three years in China ... household incomes have doubled in Brazil over the past couple of years ... and India’s economy is growing faster than 9%. Meanwhile, unemployment rates in countries like Canada and Australia are the lowest they’ve been in more than three decades.

3) Elevated inflation concerns -- While core inflation, as measured by the Personal Consumption Expenditures index excluding food and energy, has dipped below the Fed’s 2% upper boundary, overall inflation is rising. I mean, let’s be honest: Food and oil prices haven’t been "volatile." They’ve been basically going in one direction – up – for the past few years. Heck, oil prices are at a 10-month high above $72 per barrel and climbing.

Meanwhile, average hourly earnings were up 3.9% from a year ago in June (vs. estimates of a 3.7% rise). And the 10-year TIPS spread, which is the difference between yields on nominal 10-year notes and inflation protected ones has been widening little by little. It was recently 241 basis points, below its peak last May of 274 but up from the 226 low in January.

4) The falling dollar – This is another marginal negative for bonds. First, it drives up the cost of imports from abroad, adding to inflation pressures. Second, it finally seems to be encouraging foreign governments to look for other places to stash their reserves rather than just plow all that money into U.S. debt (which loses value in local currency terms when the dollar slumps).

Indeed, you’re seeing countries like China and Russia setting up sovereign investment funds. Those funds invest a portion of accumulated reserves into assets other than Treasuries, reducing demand and driving interest rates higher.


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