Is the T-Bond Bubble Bursting?

Life insurance companies tend to be major holders of long-term debt, and the reversal in longer-term treasury yields is another headache for firms like the Hartford (HIG - Analyst Report) and Metlife (MET - Analyst Report).

In the months after the last round of the credit crunch hit, yields on treasury securities fell to unprecedented lows. However, since the start of the year they have been increasing quite rapidly -- most notably in the longer maturities.

Based on the closing yields on Friday, the one-year note has moved up in yield (down in price) only slightly since the end of 2008, rising to 0.42% from 0.37%. The yield had been pretty stable at much higher levels before the fall wave of the credit crisis struck, yielding 2.12% at the beginning of September and 2.19% a year ago.

However, longer-term securities are giving up bigger chunks of their gains. Right now, the five year T-note is yielding 1.69%, up from 1.55% at the end of the year, but down from 3.00% at the beginning of September and 3.51% a year ago.

Similarly, the 10-year note is now at 2.66% up from 2.25% at the end of the year, but well below the 3.74% level at the beginning of September and 3.51% a year ago. Likewise, the 30-year bond has reversed direction, now yielding 3.38%, up from 2.69 at the end of the year, but down from 4.36% at the beginning of September and 4.23% a year ago.

So far, this reversal seems like good news, in that it could be indicating people are willing to do something with their money other than hide in treasuries. However, think of it as a warning shot across the bow: the government is going to have to raise an incredible amount of money this year, to both roll over existing debt and to fund the stimulus, bailouts and the huge pre-stimulus deficit. Almost all other governments are doing variations on the same theme.

This large demand could well start to crowd out other borrowers. Rising rates, particularly on the longer-term securities, could also be in response to fears that the huge growth in the money supply will reignite inflation down the road. They will also tend to cause mortgage rates to rise, and choke off the rebound in housing sales that we started to see this morning.

Also, one of the most compelling arguments for investing in the stock market right now is that the earnings yield (inverse of the P/E ratio) is extremely attractive relative to longer-term treasury yields. Based on 2009 expectations as of Thursday, the earnings yield on the S&P 500 is 8.62%. That, however, is likely to come down sharply as earnings expectations fall.

Then again, even in a "worst case" scenario where 2009 expectations fell in half from current levels, the earnings yield would still be well above the current 10-year note yield. A rise in the T-note yield would cut into the validity of that argument.

Life insurance companies tend to be major holders of long-term debt, and the reversal in longer-term treasury yields is another headache for firms like the Hartford (HIG - Analyst Report) and Metlife (MET - Analyst Report).



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