From deflation fear to inflation panic, so soon?
The stock market doesn't care at the moment, but things just keep getting worse in the Treasury bond market, where yields jumped again on Tuesday, reaching fresh six-month highs.
The bullish case is that investors are abandoning Treasuries because they're feeling better about the economy and would rather buy higher-risk assets (junk bonds, commodities, stocks, foreign currencies, etc.) in search of higher returns. The Dow industrials rallied almost 200 points Tuesday.
If an easing of risk aversion is mostly what the surge in Treasury yields is about, it's only a big problem for people who are loaded to the gills with government debt and don't own much else.
The bearish case is that the Treasury market is warning that inflation is headed sharply higher as the Federal Reserve keeps pumping unprecedented sums into the financial system, and as Uncle Sam borrows at a record pace to fund spending.
The supply of government debt in the market will balloon further today as the U.S. sells $35 billion in five-year T-notes. On Thursday the Treasury will sell $26 billion in seven-year notes.
As I noted in this column, the question of which 'flation to fear more -- inflation or deflation -- remains a heated debate on Wall Street.
But the inflation camp is yelling the loudest lately as Treasury yields climb.
Scott Grannis, former economist at Western Asset Management, writes on his blog that we've reached the point where the Fed should start draining money from the financial system -- a move that seems highly unlikely, given that Fed Chairman Ben S. Bernanke and his peers keep signaling a need to keep short-term interest rates near rock-bottom indefinitely.
Harvard economist Ken Rogoff hopes the Treasury market is indeed forecasting a big jump in inflation: Rogoff is advocating that the Fed pursue a policy to lift annual inflation to the 6% level "for at least a couple of years," as a way to end the deflation threat and ease the economy's debt burden. Debtors love inflation because it effectively shrinks the real cost of borrowed money.
A 6% inflation rate? If Rogoff gets his way, we ain't seen nothing yet in the run-up in Treasury yields: Even the longest-term bond, the 30-year T-bond, is yielding just shy of 4.5%. Investors presumably will want a lot more yield than that if they think they see a big inflation bump on the horizon.
-- Tom Petruno
Photo: Fed Chairman Ben S. Bernanke. Credit: Brendan Smialowski / Bloomberg News