Treasury market’s perception of recovery path is bullish, but mind the hurdles

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This post is a guest contribution by Asha Bangalore, vice president and economist at The Northern Trust  Company.

The 10-year Treasury note yield has climbed from a recent low of 2.41% (October 6-8, 2010) to 3.27% as of this writing.  The 86 bps increase in yield in a short span reflects the market’s assessment of likely improvements in economic conditions during the months ahead and the impact of a projected increase in supply of Treasury debt as a result of the compromise tax deal President Obama announced yesterday.

The bullish outlook the Treasury market is embracing is partly overdone given the significant weakness in hiring and the headwinds from the housing market that are worrisome sectors the Fed is watching closely.  Back-to-back robust monthly gains in payrolls and a sustained increase in home sales will be necessary to validate the current market perception of future economic conditions.  Between March and October of 2010, the 10-year Treasury note yield declined from 4.0% to 2.41% (see Chart 1), only to reverse it in a brief period.

Consistent with this movement, inflation expectations have also advanced 74 bps since the recent low of 149 bps on August 24, 2010 (see Chart 2).

Speaking about the housing market, the Mortgage Purchase Index of the Mortgage Bankers Association rose slightly to 210.9 for the week ended December 3 from 207.2 in the prior week.  This index has risen for three consecutive weeks, implying a likely gain in home sales during November.

Source: Asha Bangalore, Northern Trust, Daily Global Commentary, December 8, 2010.

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