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Rising bond yields signal a stronger economy




It's fascinating to watch bond yields and equities rise. Bond have been rising since the end of August, which also happened to be the time when the Fed first floated the idea of QE2. I've said before that if there was anything helpful about QE2, it would be that it effectively quashed the fears of deflation. Without deflation to worry about, the market's level of confidence in the future increased, and that in turn unleashed new jobs-creating investments. But I think there is more at work here than just the death of deflation. The politics of the electorate has undergone a huge shift; there was a major change in the balance of power in Washington; Congress is now debating how much to cut spending, not whether to raise taxes. Moreover, corporate profits have been strong for quite some time and continue to increase; business investment (capex) has been growing strongly for the past year; and businesses have undergone major adjustments in how they operate, with the result that costs have been slashed and the productivity of workers has been very high.

So rather than laud QE2 for successfully boosting the economy, I think it makes more sense to recognize that natural forces of recovery have been building for a long time, well before QE2 was first floated. This is a genuine recovery, not a figment of Fed policy, and as such it has a lot more staying power than most skeptics imagine.

It's also worth noting that two Fed governors (Fisher and Lacker) today expressed deep concerns about the wisdom of continuing the QE2 program, citing the economy's obvious improvement in recent months and the increased signs of impending inflation.

Stock prices and Treasury bond yields represent the collective wisdom of hundreds of millions of investors who control scores of trillions of dollars worth of assets. Prices and yields are rising because the outlook for the economy is improving daily. The Fed cannot ignore these powerful fundamental forces for much longer.

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