More on Interest Rates

There are some really good comments in the interest rate post.  RW thinks the yield curve is just the normal sign of healthy growth returning:

The usual school of thought is that steepness signifies growth, because bonds yields have to rise in order to compete with stocks.

It's an inverted yield curve that signifies problems, not a steep one. Go back in history to look at when the curve was this steep, and good things generally happened thereafter. An inverted curve leads recessions.

It also seems that you've redefined what it is. The yield curve is typically the spread between the 10-year and the 3-month. As I type this, that's 368 bp. We've certainly been at these levels before, and no apocalypse came of it on those other occasions.

The one possible problem at the moment is mortgage rates. However, mortgage rates are not tied directly to the long bond, and bank spreads are exceptionally high at the moment (they get much of their money for next to nothing), so they have room to cut their spreads and still be profitable.

A some thoughts in response:

• I don't think there's any one interpretation of a steepening yield curve.  It can be inflationary expectations, it can be default risk, it can be equity markets perking up, or any number of idiosyncratic factors on a given day.  In this case, however, traders say they're worried about inflation and the size of the government debt.  And the equity market looks pretty fully priced, at least on EPS.
• Likewise, obviously a steepening yield curve does not necessarily herald an apocalypse.  And it's certainly too early to say it does so right now.
• The question is, what does the steepening yield curve mean in this context.  And right now, I think it at least calls into question the idea that rising interest rates simply herald a reversal of the winter's "flight to quality".  The flight to quality happened across government securities.  It's reversing much more unevenly.  Maybe that's because traders are expecting growth.  But maybe because they're expecting infaltion or default.  The traders themselves seem to be saying the latter, at least to financial reporters.
• That said, I don't think these things are reasons for hysteria.  They're possible reasons--good ones, I think--not to be as optimistic as the Pollyannas.
• An inverted yield curve usually signals recession, but that's because it's a sign the Fed has overtightened.  This is not a worry now.  But that does not mean that everything's fine.  Yield curves can signal more than one problem, in more than one way.
• There may be ample room for mortgage lenders to cut.  But they're not.  Why?  Another data point that does not suggest optimism.

Meanwhile, AT QB says:

The curve is steepening in part because of *where* the Fed is choosing to buy. They've chosen not to defend the 10 year rate.

The below bond investor makes the point that they are doing this because they believe the belly of the curve has more influence on consumer borrowing rates.

http://accruedint.blogspot.com/2009/04/fed-to-treasury-market-it-is-you-who.html

But reader lc thinks I'm being too optimistic:

My only quibble is your characterization of the move in interest rates as an uptick. Bond markets are getting routed, and the real problem is that there is an enormous amount of additional supply coming onto the market.

Further many large foreign buyers are already signalling interest in moving away from treasuries. This is going to get worse before it gets better, especially if we spend north of $1 Trillion on healthcare reform.

I presume bond investors would be find if we spent $1 trillion on healthcare reform, and raised taxes to pay for it.  (Oh, hear that hollow laugh).  But the foreign investors are a huge worry, one I meant to mention.  Russia is just another in a long line of large countries saying they plan to diversify out of Treasuries.