Economic Summary April 2, 2010, A. Langes, Richmond Hill, GA

Weekly Economic Summaries are submitted courtesy of Richmond Hill, GA mortgage broker, Aaron Langes. Aaron is a Loan Officer with Bank of America, a preferred partner of Keller Williams Realty, Richmond Hill. Please note that this is Aaron’s (912.678.6063) area of expertise and I provide the information as a resource – in other words, he can answer your questions better than I can

OVERVIEW ~ The credit markets moved from calm to confusing over the week of March 22 through 26. The 10-year Treasury note yield climbed from 3.689% at Monday’s opening to 3.852% at the close on Friday.

FOCUS ~ Three apparent causes of rising interest rates from March 22 through 26 raised some difficult questions. What are recent investor decisions, as suggested by their actions, telling us?

First, it was another week of large Treasury security auctions, this time offering 2-year, 5-year and 7-year notes. Ironically, the day before the auctions began, The Wall Street Journal ran a story declaring that since Inflation was currently “dead,” we could expect to see the kind of heavy demand for Treasury notes that we’ve seen in other recent auctions. But we didn’t. Why?

Second, global investors were visibly worried by debt troubles in the euro region; they pushed the dollar far higher against the euro. But this has usually meant an influx of investor dollars into the safe haven of Treasury securities. This time, though, the connection between a higher dollar and elevated demand for Treasury securities didn’t hold. Why?

Third is a rather obscure hedging strategy that involves trading the income stream from Treasury securities for the income stream from floating-rate corporate bonds. The corporate bonds have always provided a slightly higher yield because they haven’t been considered as safe as the Treasury securities, which are backed by the full faith and credit of the U.S. government. Last week, though, their yield in this swap arrangement actually fell below the yield of Treasury securities for the first time ever, suggesting that investors felt safer with the corporate bonds than with the Treasury securities. Why?

We just don’t yet know why these odd events are taking place. But this is a topsy-turvy set of actions, and it suggests, at least, that investors all over the world may be losing confidence in government securities. Until now, less confidence in foreign securities has only reinforced confidence in American securities. But investors seem to be taking a dimmer view of American securities now, and if they continue, it could push interest rates still higher, as it did this week. Higher rates in the market could force the Federal Reserve’s hand as well, making it difficult to maintain lower short-term rates for much longer. It is a time to watch the Treasury securities markets with special care.