A Warming Economy Burns Bonds
But will rising rates choke off the consumer-led recovery?
Tracking bonds is usually as exciting as watching paint dry. But in recent weeks, bond prices have plummeted in a dramatic, violent stroke worthy of a Jackson Pollock painting, pointing to economic growth on the horizon but threatening the strength of the consumer-led recovery at the same time.
Since mid-June, 10-year treasury notes have taken a historic nose dive, driving their yields up from a 45-year low of 3.11 percent to 4.44 percent last week, a one-year high. "This is one of the largest moves in the bond market in 16 years," says Robert Gahagan, head of taxable bonds for American Century Investments.
Bloodbath. Bonds thrive in slow- or no-growth environments, so recent news signaling economic expansion--second-quarter gross domestic product growth came in much stronger than expected--has contributed to the bloodbath in bonds. "Compounding the problem is the massive amount of supply coming onto the market," says Dan Shackelford, senior portfolio manager with T. Rowe Price. To finance the growing deficit, the Treasury will offer a record $60 billion in debt this week, on top of last quarter's $58 billion. More supply and less demand equal falling prices.
There's also the fact that when rates were falling, investors in mortgage-backed securities bought treasuries to hedge their portfolios. But now that rates are rising, those same investors are being forced to sell treasuries to reverse their positions. Another factor at work: Individuals are fleeing bonds in favor of the hot stock market.
Normally, rising bond yields are good news, since they imply that the economy is improving. But the irony is, the more traders anticipate a robust recovery by aggressively dumping treasuries, the less robust the recovery is likely to be, says Eaton Vance economist Robert MacIntosh.
That's because 10-year treasury notes influence mortgage rates. As treasury yields have soared, average rates on 30-year fixed-rate mortgages have jumped from 5.21 percent in mid-June to 6.14 percent last week. Not surprisingly, refinancing activity, which has juiced the economy by putting more dollars in workers' wallets, has fallen off a cliff, dropping 33 percent in the week ended July 25.
Refinancing activity is still relatively healthy, but "the boom is over," says Jay Brinkmann, a vice president of the Mortgage Bankers Association. That could mean that the one safety net the economy had--continued consumer spending--may be threatened. This puts even more pressure on businesses to step up capital spending and hiring, elements that have been missing in this economic recovery. Says Marilyn Cohen of Envision Capital: "Corporate America better pick up capital spending--or else."
RATES ON THE RISE
The yield on the 10-year Treasury note has soared in recent weeks.
[Complete chart data are not available.]
[labels]
Aug. 2002 4.47
3.13
Aug. 1st, 2003 4.44
Source: Federal Reserve
This story appears in the August 11, 2003 print edition of U.S. News & World Report.
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