The inability of folks in Washington and the media to even attempt to address the issue of long-term fiscal sustainability has never been more obvious. Neither party made any attempt to even begin to address the unsustainable levels of debt and entitlements. Folks cheer that the government can reopen and the nations's debt increase without realizing the consequences. Debt will start increasing once again and nothing was done to address the massive underfunding of Medicare and Social Security - amounts which exceed the wealth of everyone in the nation added together.
The fact that Treasury yields fell right after the shutdown ended appears to contradict my view that yields were falling because of flight-to-quality buying of Treasuries. What we had yesterday may have been a short squeeze.
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Concerns about U.S. Treasury Debt Yields
We folks in the mortgage business are always concerned about interest rates. When I log on to my RPM server to access all that I need to do my work, across the top of the site are constant updates for the prices of FNMA paper of various yields. In general those yields move in harmony with U.S. Treasury yields and are most closely correlated with the 10-year Treasury yield. That is why these weekly newsletters contain an analysis of where those yields (and consequently home loan rates) are headed.
It used to be the case that interest rates to bondholders were driven by inflation, or, more accurately, the perception as to where inflation is going. This assumes the the bond market is operating in a free market manner with informed buyers and sellers and the usual caveats. The problem is that as of late, Treasury markets have not really been operating in any manner which is traditional. The Federal Reserve through QE has been purchasing $85 billion per month of Treasury debt and GNMA mortgage debt.
Unless I am missing something the Treasury Department had stopped funding certain government pension funds in order to stay under the debt ceiling. The implication is that there is some amount of delayed debt ($300 billion+ which is money Treasury did not put into certain pensions funds for government employees) in addition to any new debt. If Treasury goes out and sells new debt on the market it may find that the market is not receptive and yields may rise.
In the longer term it is the Federal Reserve which has been supporting Treasury prices and keeping yields (and home loan rates) low. Once the Fed ends QE there will be only 2 large potential buyers for Treasury debt - China and Japan. I believe that neither of them will have any interest in purchasing Treasury debt at current yields. They will point to the recent inability of Washington to manage itself and say something akin to, "you have to be nuts to ask us to loan you money at 2.5% for 10-years when you have no ability to 1) keep the store open or 2) demonstrate any long-term plan for fiscal sustainability. We will not buy this paper at these yields and you folks have no one but yourselves to blame."
China may be forced to do this because it has a well-hidden banking/shadow banking problems. If China decides to admit to and address its problems it may be more interested in self-preservation than supporting the inability of the U.S. to even try to achieve fiscal sustainability.
In any case, the first test will likely be when the Fed ends QE. My point-of-view is that bad fiscal policy may be driving bad monetary policy.
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