Mar 22, 2008

Economy - Is the worst over, or just beginning?

Falling long-term Treasury yields could eventually help consumers - but also may be a sign of continued concern about the economy.

Bond yields have plunged in the past few weeks. And even if you are not an active investor, you should care about what's been going on in the bond markets lately. Here's why.

The yield on the benchmark U.S. 10-year Treasury currently stands at about 3.33%, down from nearly 4% about a month ago. The rate on this long-term government note is a key factor behind what happens to fixed-rate mortgages.

If rates continue to fall, they could hit not only a new low for the year - the 10-year briefly touched 3.28% in January - but could come close to falling below the 3.07% level they hit in June 2003, which was a 45-year low at the time.

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Other Treasury rates have also fallen sharply. The yield on the U.S. 2-year Treasury is now only 1.58%. The rates on these issues influence the rates for other types of consumer loans, as well as small business loans.

The fact that rates are this low is a sign of just how weak the economy is, since lower rates usually correspond with tougher economic stretches while rising rates are often a product of a robust economy.

Still, on the surface, falling longer-term yields should be a relief for consumers. The problem is that loan rates have not fallen as far as they should considering how much yields have declined because of the problems in the credit markets from the subprime mortgage meltdown.

"Fixed-rate mortgages are around 5.8%, substantially above a 3.3% 10-year note. What's happened is while Treasury yields are falling, private sector rates have not moved much. Mortgage brokers and consumers might be surprised rates aren't lower. But the mortgage market is gummed up," said Steve Van Order, chief fixed income strategist with Calvert Funds.

But Van Order thinks that some of the actions the Fed has taken in the past few months - including six interest rate cuts since September as well as the introduction of several loan facilities to provide much-needed cash to struggling banks - could eventually get banks to turn on the lending spigot again.

Several other bond experts agreed that there is some good news to be found, but that it will take time before banks are comfortable lending even to high-quality borrowers again.

"Treasury yields coming down are good for consumers," said Stephen Cooke, director of credit research SMH Capital Advisors, Inc, a firm that primarily invests in high-yield bonds. "And certainly in this environment, it makes borrowing more affordable for all sorts of things."

"However, in this credit crunch, companies still aren't lending," he added. "It will take a while for credit to loosen up and for low rates to flow through and help the economy." Full Story