Bond Prices

[chippp]

"U.S. Treasuries were little changed, with yields on two-year notes at their highest in more than 5 1/2 years, on expectations the Federal Reserve will increase interest rates at least twice more this year. " -Bloomberg 6/21/2006

http://www.bloomberg.com/markets/rates/index.html

Can someone explain this current phenomena:
2 yr note yields 5.19% whereas 10 yr note yields 5.14%

Based merely on yield-to-maturity, how is it possible that the market can price the shorter term notes into a higher yield? Does it make sense at all? And if it does to you, can you explain why?

Another question - Fed's interest rate hikes can cause investors to flock from their stocks to fixed incomes such as the treasuries. Wouldn't the demand spike for notes cause their prices to go up and hence in turn lower their yields? (then wouldn't that defy the textbook logic of "interest rates go up = bonds prices go down"?)


Thanks in advance.
chippp

 

[noseykibitzer]

Inverted yield curve has been the precursor for the last 4-5 recessions if I remember correctly. Its only gonna become more inverted because the inflation fears, which are clearly prevalent, and the need to for the Bernanke to crank up short term rates to quell the problem if he can...I read a pretty extensive article in the economist a few months ago and some where suggesting that the global economy is juiced enough to be not so reliant on the US rate/inflation situation alone...so this may prevent a recession but eventually it all catches up...just look at the markets all across the middle east since the beginning of the year, and some smaller countries having some potential recessionary difficulties.

Been moving my money out of stocks across the board with the exception of getting back in some of my commodity plays, TIE, BHP, ...look for the end of the summer to really see what is gonna happen toward the end of the year. The volatility in the most recent weeks happened a little sooner than typically expected usually you get is what I call the mid-summer thaw...when the market gets real choppy, happens like clock work almost every year.

There are so many variables that contribute to the situation...but don't forget about all the real estate speculators that took out an ARM, interest only, or reverse amorization loans...all those get periodically reset and it is gonna crush people. So keep your powder dry and look for foreclosures to start kicking in...

 

[sugar01]

Hi Chippp,

This is an interesting topic. Based on MY opinion, we should blame investors for these phenomena. Investors� speculations cause the market to fluctuate, and misbehave. We EXPECT, SPECUTLATE that interest rate will double/rise, but interest rates haven�t risen yet.

So your question �Does it make sense at all?� No it does not. This is why lots of money goes into understanding investors� psychology.

Please feel free to criticize my opinion.

 

[shadefx]

stock prices are discounted using the rfr and risk premeium
so when rates go up, stocks decline...this is a lot of your movement down...

 

[chippp]

It's interesting isnt it...sugar01?

Nosey brought up an interesting aspect of the inverted yield curve...that is the strong plays in countries such as China and India are making this current global economy resilient to, or rather more independent, of the US inflation...and with that, do we throw out all predictive theories?

My opnion is that the current economy is currently too unpredictable due to changing global dynamics...


'Nothing is certain but death and taxes'

Franklin's law

 

[noseykibitzer]

True if you are looking at looking at a formula to assess the PV of a stock...but the empirical side is that inflation erodes profits...as a simple example...you have companies that are in variable PO's on the back end and LT fixed or incremental price contracts on the front end...when prices rise such as a FSC (Fuel Surcharge) on shipping that comes right out of the margin...and take that non-value added cost and carry it across several production layers and you can see the effect.

The other side of the coin is that more expensive money especially on the short end of the curve really puts dent in desire or ability for smaller companies (with less access to capital markets) to employ additional resources. Think of all the smaller outfits who use an LOC to fund short-term operations...compare Libor today to 24 months ago and you can see the difference.

As far as the treasury curve...its not speculation its necessity, just keep in mind who buys our bonds or should I say who funds our budget deficits...its not American investors. China needs to keep buying our bonds to keep the yuan pegged...this has sort of artifically kept the longer term rates low.

 

[sydneybound]

and the reason that an inverted yield curve is seen as a precursor to a recession is because it is assumed that the market can tell if a recession is to happen (because the market makes the curve what it is).

the reason why long bonds have a lower yield is because the market sees short term rates going up (as per Fed indication) but that these will have to be slashed when the economy goes through the upcoming recession that the market predicts. understood?

there are so many variables actually at play, but its important to understand the theoretical fundamentals anyway. and yes, the fact that 50% of US gov't debt is now overseas is a huge factor on the yield curve. the chinese are vendor-financing the US economy, beautiful isn't it?