An article about U.S. Treasury bonds in today’s Wall Street Journal made it very clear that interest rates have gone global, especially for high quality bonds. The article pointed out that at the close of business this past Friday, the 10-year Treasury bond carried an interest rate of 2.597%. Given the growth prospects of the U.S. and political stability, the U.S. Treasury bond is of very high quality.

Two other countries whose 10-year bonds are considered high quality are Japan and Germany. In the case of Japan, the rate was 0.6% on Friday, while for Germany it was 1.31%. You can see how an investor in either of these two countries might prefer to buy the U.S. bond.

Looking at lesser-quality 10-year bonds for countries like Spain, 2.652%, and Italy, 2.769%, the higher quality of the U.S. bond, with a similar rate, is also very attractive. The 10-year Treasury was above 3% fairly recently, and prospects were that it would go higher.

This globalization of bonds has helped drive the interest rate back down. We have seen this happening with high-quality U.S. corporate bonds as well. When interest rates decrease, the value of bonds rises. This recovery in bonds, since last year, means that while bonds lost value last year, they have gained it back this year, in most cases.

Part of the shift in the 10-year Treasury bond has been less borrowing by the U.S. government. The Congressional Budget Office estimates that the deficit for fiscal 2014 will be about $492 billion, which is the lowest since 2007. Since the U.S. government needs to borrow less, fewer 10-year Treasury bonds are available. Supply and demand take over, with the demand for the Treasury bonds outstripping the availability and pushing rates down.

While it all seems so matter of fact, as the global economies begin to grow, an increasing supply of high quality bonds will begin to outstrip the demand, with interest rates increasing and the value of bonds dropping. This can happen very quickly, just as we saw the 10-year Treasury drop from 3% to 2.4%. This change in interest rate direction will likely take place sometime in the second half of 2014, but don’t bet on it!

Ed Mallon

Posted June 9, 2014 at 3:59 PM