Ishares Trust Barclays 20plus Treasury Bond ETF (TLT)

[frenchee]

Little Safety in 10-Year T-Notes
By PETER EAVIS


To paraphrase Churchill, the 10-year Treasury note right now is an enigma wrapped in a mystery, contained in a riddle.

A big head-scratcher for investors is figuring out the appropriate yield on such government bonds. They yielded 3.97% Friday, up from an October low of 3.43%.

On paper, that increase shouldn't be happening. The Federal Reserve is expected to take its fed-funds target rate below 1%. And, this past week, a range of economic indicators proved that the recession is real and getting worse.

Seeing that, investors might be expected to pile into the 10-year, pushing its yield down to 3% or lower, in the belief that deflation is a real threat and interest rates will just keep heading lower. In other words, the 10-year Treasury would start mimicking the 10-year Japanese government bond. Over the past 10 years, a period when Japan's economy has sputtered along, the yield on 10-year JGBs has rarely gone above 2%.

Why isn't that happening?

One interpretation is that government bond investors simply don't think the U.S. is entering a deflationary lost decade. They see all the things the Fed and the U.S. Treasury have done to prevent collapse and are betting that, after a recession, the economy recovers. That means inflation could return as a factor -- and to compensate for that risk over 10 years, the bond needs to yield more than the historically low rate of 3.97%.

There is a darker viewpoint: Investors will demand relatively high yields on longer-term Treasurys even if the U.S. economy continues to weaken.

Two things could keep yields high. First, the U.S. relies on foreigners to finance its current account deficit. It may have to pay up to maintain foreign buying of U.S. government bonds. Japan never had this weakness. Second, bond buyers -- seeing how much money the authorities are throwing around -- expect the volume of government debt to skyrocket.

That could be exacerbated by the government's recent moves to guarantee large amounts of bank and agency debt. If investors believe in those backstops, the yield between such securities and Treasurys should move closer, potentially pushing up Treasury yields.

The sticking point in Japan was that monetary easing and capital injections into banks didn't translate into a big pickup in lending. That might be different in the U.S. because the authorities have moved quickly, though the preceding credit boom was arguably worse, making the bust harder to neutralize and the potential effects on the real economy more severe.

With coming economic data set to show serious weakness, 10-year yields could well retreat again short term. But on a three-year view, with the U.S. determined to reflate the economy at almost any cost, and borrow heavily to do so, 10-year Treasurys are no safe bet.