mish27

Notes From the Rabbit Hole

I'll Take the Under

By Mike Shedlock

December 29, 2009

David Greenlaw, chief fixed-income economist at Morgan Stanley Sees 5.5% Note as U.S. Faces Deficits.

If Morgan Stanley is right, the best sale of U.S. Treasuries for 2010 may be the short sale.

Yields on benchmark 10-year notes will climb about 40 percent to 5.5 percent, the biggest annual increase since 1999, according to David Greenlaw, chief fixed-income economist at Morgan Stanley in New York. The surge will push interest rates on 30-year fixed mortgages to 7.5 percent to 8 percent, almost the highest in a decade, Greenlaw said.

When you take these kinds of aggressive policy actions to prevent a depression, you have to clean up after yourself,” Greenlaw said in a telephone interview. “Market signals will ultimately spur some policy action but I’m not naive enough to think it will be a very pleasant environment.”

Speculators, including hedge-fund managers, increased bets that 10-year note futures would decline more than fivefold in the week ending Dec. 15, according to U.S. Commodity Futures Trading Commission data. Speculative short positions, or bets prices will fall, outnumbered long positions by 52,781 contracts on the Chicago Board of Trade. It was the biggest increase since October 2008.

Edward McKelvey, senior economist in New York at Goldman Sachs Group Inc., the top-ranked U.S. economic forecasters in 2009, according to data compiled by Bloomberg, expects yields to drop to 3.25 percent. Goldman Sachs says unemployment will average 10.3 percent in 2010, hindering the recovery.

“This is the re-emergence of the bond market vigilantes,” said Mitchell Stapley, the Grand Rapids, Michigan-based chief fixed-income officer for Fifth Third Asset Management, who oversees $22 billion. “The vigilantes are saying, OK guys you want to do this, you’re going to pay a higher price for it.”

I'll Easily Take The Under

5.5% on 10-year treasuries? I'll take the under. I'll also take the under on 7.5% mortgages as well.

Goldman Sachs' call for 3.25% on the 10-year based on the unemployment rate averaging 10.3% seems like a very good guess. However, anything from 2.75% to 4.75% should be in the ballpark.

I freely admit 2 points is a very large park. Yet, as wide as that range is, it is quite possible that we see something near both ends of that range at some point during the year given the factors in play.

Six Factors In Play

If there is a spike, it is far more likely earlier in the year than later and we are headed into 2010 currently at 3.84%. Another 75 basis points certainly seems possible with the "hate treasury trade" back in vogue.

Treasuries are in an unseasonably favorable period right now, and that lasts all the way through May.

If there is a chain of favorable data such as a surprise to the upside in GDP for the 4th quarter of 2009 or 1st quarter of 2010, that too can contribute to a spike in yields. But all the way to 5.5%? Sustained? I'll put the odds of that at 15%.

Most analysts seem cock-sure the bottom in the stock is in and we are off to the races. The bottom may be in, but even if so the odds of a hard correction are very high in my opinion. Should that happen, there can easily be another flight to safety trade.

Unemployment is unlikely to dip substantially below 10% in 2010 and could easily rise to 11%+. That would kill a sustained rise in consumer spending, put a damper on earnings, and lead to higher chargeoffs on credit cards. Such events would be favorable for treasuries.

The global recovery can easily falter in the second half of 2010. That too would be favorable for government bonds in general.

Wildcard: Congress may go berserk with additional fiscal stimulus efforts. Note this would be a two-edged sword. If Congress does go berserk , the economy would likely be in the gutter and yields already falling even though the action itself would be supportive of higher yields.

The concentration of upside yield risks in the first half, and downside yield risks in the second half account for the large ballpark for where yields may go in 2010. For where the 10-year note ends 2010, I will guess a much narrower 3.0% to 3.5%.

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