Reprinted with permission from World Finance Net IPO Newsletter, written by Alexander Frauenfeld

Ten-Year Treasury Benchmark?

Get used to it, is the word on the Street, as we see the youthful 10-year note government security dethroning the widely quoted, highly esteemed 30-year bond from its bellwether perch.

Treasury bills, notes, and bonds have for a long time been the standard for safety. Everything is considered relative to Treasuries; there is no safer investment in the US or anywhere else in the world, for that matter. This is so because they are backed by the "Full Faith and Credit" of the United States. While that remains the case, the market appears to have switched its focus away from the long-term (30 year) bonds, the longstanding benchmark, to the intermediate term (1-10 years) notes.

The switch began late last month when the Treasury Department, faced with the first budget surpluses in a generation, announced that it would reduce issuance of long-term debt. Fear of fewer securities drew a flood of buyers to the 30-year bond, sending its yield, which moves inversely to its price, plunging below yields of nearly every security issued by the government.

For the $14 trillion fixed-income market, this is very, very big. Suddenly, corporations, municipalities and foreign governments who for years priced bond sales based on the 30-year yield lost their relevant benchmark.

And analysts looking to gauge market reaction to economic indicators, such as employment reports, no longer have a reliable weathervane of inflation expectations. That is because the bond's yield, which once constituted a bet on expectations for inflation, has instead become a barometer for the government's contracting bond supply. Therefore, the 30-year seems to have lost its bellwether status because its yields are a response to (shrinking) supply.

In contrast, the 10-year note mostly escaped this panicked, supply-driven buying. As such, its yield is a better take on what constitutes a competitive return on investment after inflation. So, if you want to assess the market's true feeling about underlying (economic) fundamentals, you have to look at the 10-year or bonds of even shorter maturities.

Tempora mutantur (times change), and so do benchmarks, which tend to come and go. The demise of the 30-year can be traced to an economy that has entered its 107th month of expansion, which, by the way, is the longest on record. For years, government debt grew. But a recent surge in tax receipts, fed by the expansion, means that the Treasury no longer needs to borrow money like it once did.

A parallel seemingly exists in the stock market as well. The DOW, loaded with older economy stocks such as General Electric (GE), General Motors (GM) and Alcoa (AA), has faced questions about its relevance. As a widely quoted index, the DOW competes with the NASDAQ, whose technology stocks have led the economy's growth for a while now. In an effort to keep pace with the change, Dow Jones & Company (DJ), publisher of the index, last year made some major but timely changes by added Intel (INTC) and Microsoft (MSFT). (See Major Dow Changes.) This dramatic change gave the century-old index its first ever NASDAQ stocks.

Moreover, gold may no longer be the inflation hedge it once was. And rising oil prices may not be able to cripple the new economy the way it hamstrung consumers in the 1970s. Times do change.

For consumers, the resulting drop in yields means lower borrowing costs, even as the Federal Reserve is expected to raise interest rates at least once more this year and most likely within the next couple of weeks at its March meeting.

The bond reduction also raises some important global questions. Faced with financial crisis in 1998, Asian and Russian institutions parked money in the relative safety of Treasuries. This flood of funds pushed the yield on the 30-year Treasury bond to a lifetime low of 4.72%. If the entire Treasury supply shrinks, as Treasury Secretary Lawrence Summers recently suggested it might, those seeking a safe haven should consider going elsewhere.
The long bond is dead. Long live the short term treasury.


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