Tags: hans | parisis | fed | exit | bond | yields

Fed's Mortgage Exit to Boost 10-Year Bond Yields

By Hans Parisis   |   Wednesday, 31 Mar 2010 10:41 AM

The Federal Reserve's $1.25 trillion mortgage-bond purchase program ends today and many experts think we’re facing the risk of rising longer-term interest rates.

On March 18, 2009, the Fed expanded its program to buy $1.25 trillion in mortgage securities, along with $200 billion in debt of Fannie and Freddie and as much as $300 billion in long-term Treasury debt.

The expansion fueled bond markets to rally (higher prices mean lower yields) to unsustainable levels.

Remember, before that in December 2008, the Fed cut its federal-funds rate, which is their overnight-lending rate to practically zero.

From then on, holding cash yielded practically nothing and it cost next to nothing to borrow money to invest in “whatever” and “wherever” investors saw opportunities and could put their hands on.

The Fed incited and rewarded risk-taking as never before. That’s now coming to an end.

In this context, I can’t see 10-year yields remaining where they are now or even going lower. (They are around 3.8276 percent now). On the contrary, I expect them to rise above 5 percent in the future.

That doesn’t mean that the Fed will raise its federal-funds rate, its overnight-lending rate, substantially anytime soon. In fact, it all will come down to: “Yields will have to be high enough to convince private demand now the Fed is no more a buyer.”

Meanwhile, in Europe, we’re seeing that investors don’t share the European politicians’ optimism on how to solve the Greek problem.

Investors don’t show confidence also because the European Commission and the European Central Bank (ECB) didn’t say what options would be considered to “reinforce the legal network” of the fiscal stability pact and what would happen were another nation were to find itself in trouble.

In fact, for now, investors are showing little appetite to increase their exposure to Greece.

Tuesday, Greece unexpectedly reopened an earlier 12-year bond issuance, with the yield capped at 6 percent, and they only managed to raise 390 million euros ($526.75 billion) of the 1 billion euros that were available.

When we take into account that Greece has only raised about half of the 35 billion euros they need this year while investors are increasingly shunning its debt despite the apparent promise of a euro zone backstop aren’t boding well.

This morning, the benchmark 10-year Greek/German yield spread on government bonds has started widening out once again, hitting 335 basis points.

Given all this, I remain bearish for the euro.

I’m convinced its current downtrend is far from over.

It’s simple: The euro is still too expensive.

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