Over the past month, interest rates have increase from 2.62% to 3.3%. In Monday's FT, the paper proffers three reasons for the increase: better economic news, indicating a move from safe haven Treasuries to equities is warranted, higher inflation expectations and the Fed will not engage in QE2 because of the political backlash. To this, I will add a fourth, which is concern for the U.S.' fiscal situation.
Let's take these one at a time:
Better economic news: Outside of employment, the news has been positive. Retail sales are strong, household net worth is up, initial unemployment claims appear to be decreasing, manufacturing is still strong and the tax deal went through Congress. In short, it appears that things are looking up after the stall caused by the Spring. Good news means that companies should see an increase in earnings, which raises equity valuations, making bonds less attractive.
Higher inflation expectations: These are being stoked by the decreasing dollar and its negative impact on commodity prices (which move inversely to the dollar). More precisely, oil's recent increase to around $90/bbl is adding to inflationary concern. However, the US CPI number is still very low -- especially year over year -- so I really don't see this being a root cause of the Treasury sell-off.
The Fed will back off QE2: not according to yesterday's Fed statement.
The tax deal will lead to a worsening of the US fiscal situation: the markets have dropped sharply since the deal was passed, indicating the deal is probably leading to concern about future debt issuance from the U.S. The bottom line is the tax deal will lead to lower revenue for the government, meaning the US is not serious about its fiscal health.
I think its about 50/50 between the better economic news and the tax deal. There is no way to empirically prove this breakdown; its merely an intuitive guess.
