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Yields rise as the economic outlook improves

Yields on 10-yr Treasury bonds are now just 1 basis point shy of their highest level in the past year. As I've said before, these yields are best viewed as a barometer of the market's expectations for future economic growth, and I've indicated that with the shaded areas on the chart. At the end of 2008 yields plunged to 2% as the market priced in expectations for a deep depression and deflation. Today the market is pricing in some growth, probably on the order of the 2-2.5% growth forecasts that are common to those who believe in an extended "new-normal" period of sluggish growth.

It's my impression that most people worry that higher bond yields will choke off growth, but I thing it's the other way around. Growth fundamentals are improving, so bond yields are rising. That's only natural, since Treasury yields need to compete with the returns that can be generated by the economy, and those returns are, in turn, a function of the rate of economic growth. It would take bond yields of at least 6 or 7% and a concerted effort by the Fed to tighten before rising interest rates might prove harmful to growth.

The jobs growth we have seen so far this year is very welcome, but it does not yet signal that growth will be robust. It takes about 130K new jobs per month just to keep up with the normal expansion of the labor force, and more than that to bring about a decline in the unemployment rate. On the margin, the changes we are seeing are definitely positive, and there is likely to be further improvement in the pace of job creation later this year. On balance I think this adds up to a positive for the market, since I think the consensus is still somewhat pessimistic about the prospects for future growth.

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