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Subject:  Whither the 10 Year Treasury? Date:  7/27/2009  10:20 PM
Author:  WendyBG Number:  28308 of 36506

There was a huge discontinuity in the 10 Y Treasury market, due to panic flight-to-safety buying during the crisis of 4Q 2008- 1Q 2009.

The chart below shows the trend of the 10 Y Treasury from 1982 and also shows the real (inflation adjusted) rate as well as the nominal rate.

The 10Y has been in a secular downtrend since 1982, with lower highs and lower lows (yields). This is partly because of declining inflation, and partly because of higher bidding by U.S. trading partners, which drive the price higher and the yield lower.

These trading partners are eager to keep their own currencies low, so they are less sensitive to real yield than they are to investing in a safe dollar-denominated investment.

The long-term nominal trend line has not been broken in a meaningful way recently. The recent nominal rate is simply bouncing back to a more normal level from the panic flight-to-safety buying of the 2008 crisis. It's normal for 10Y yields to peak in July -- that happens every year. There should be some minor bouncing around, then a decline in yields going into later 2009.$TNX

The really unusual action is not the nominal yield, which is normalizing to the pre-crisis level, but the real (inflation adjusted) yield, which is unusually high. Inflation has been abnormally low in early 2009, due to the popping of the energy price bubble in July 2008. According to, most of the deflation in 4Q2008- 1Q 2009 was due to lower energy prices.

As we all know, energy prices have risen since their nadir in early 2009.

With the real yield of the 10 Year Treasury so high, I would expect either an increase of inflation or a decrease in yields, or both.

Only a tremendous issuance of Treasuries, overwhelming demand, will keep prices low and real yields high if inflation is zero or less. As usual, Mish is predicting deflation. If he is right, real yields will be unusually high and Treasuries will be a fine investment -- unless the government issues too many.

There will be record Treasury sales tomorrow and in August. If demand is strong, the yields will be stable to down. If demand is weak, yields will rise.

I am interested in the 10 year Treasury because it affects mortgage rates, and I have shares in Vanguard GNMA fund.

I posted this on METAR because of the Macro underpinning, but I would also like comments from the Bond Board.

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