Interest Rates Jump On Weak Treasury Auction

A sharp jump in interest rates took place today amid concerns over sovereign debt in Europe and a weak auction for U.S. Treasuries.  Markets may be signaling concern over swelling government deficits, a problem that could get worse if the current economic recovery stalls because tax revenues are likely to fall.

U.S. interest rates remain at low levels but could advance quickly if U.S. Treasury auctions remain weak.  Below is a look at yields for five (2.57%), ten (3.83%) and thirty (4.72%) year Treasuries.

It may be early to call a bottom in U.S. interest rates, but in other parts of the debt market complacency may be back.  The spread between corporate investment grade bonds and corporate junk bonds has narrowed to around 3.9%.  At the height of the credit crisis spreads widened to as much as 16%.  Is an 8.36% yield (the 30-day SEC yield on HYG, a junk bond index ETF) high enough to compensate for default risk in this economic environment?

The bond market has known for some time the Fed would halt purchasing mortgage debt at the end of this month, which many commentators expect to cause mortgage rates to rise.  Sovereign debt trouble has been in the headlines for months. What is new today is a weak Treasury auction.  This could mark the beginning of a new direction for U.S. interest rates.  It will be interesting to see the results of tomorrow's $32 billion auction in 7 year notes.  And for the rest of the foreseeable future the U.S. will be going to the debt market to fund our spending.  If higher interest rates accompany new U.S. debt issues, the amount of tax revenues going toward interest payments increases, decreasing our ability to pay down debt.

The dollar has held up in the latest chapter of the ongoing credit crisis.  If global economic growth weakens, demand for dollars could decline and send the buck lower.  A declining dollar combined with rising U.S. interest rates would present U.S. investors with a very challenging environment.  It is a good time to pay attention to both interest rates and the dollar.  Regardless of how market action unfolds, we are prepared at DCG to take a variety of actions to both protect and profit.  Let us know if we can help.