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So far 2013 has been an exciting year for the bond market.  Junk bond yields have dropped below 6% for the first time ever, while at the same time the yield on the 10 year treasury has moved significantly higher.  With this in mind, I thought it would be constructive to have a look back at what we can learn from this, and what insight current price levels may give us into future price action.

To see a list of high yielding CDs go here.

The 10 Year Treasury

As you can see from the below chart, the 10 year treasury yield has been on a steady march higher since late December, recently crossing back above 2% for the first time since April of last year.

What caused the rise in yields?

In my opinion there are several different factors, however all of them relate either directly or indirectly to the Fed.  If you pay much attention to the news this may seem counterintuitive, as everything you read says the Fed’s intervention into the market is keeping rates low.  As I explain here however, this is not actually the case.  In September of 2012 the Fed announced unlimited quantitative easing, and that they were increasing the amount of treasuries and mortgage backed securities that they were buying to $85 Billion a month.

What really got the market moving however was when they announced that they would be specifically targeting unemployment, with the goal of continuing their intervention into the market until the unemployment rate drops below 6.5%.  This increased the market’s inflation expectations, sending rates higher.

The “resolution” or at least kicking of the fiscal cliff can down the road also played a role, as it removed a level of uncertainty from the market early in the year.  All of this, combined with a more stable situation in Europe, has investors in a “risk on” mood.  When this happens money flows out of bonds and into stocks, sending bond yields higher (their prices lower) and stock prices higher.

The bursting of a bond bubble?

If you follow the markets at all you are probably reading at least 1 article a day about the bursting of “the bond bubble”.  What those articles authors fail to mention however, is that they have been writing the same article for years now.  This is the 5th year in a row that the 10 year treasury rate has risen going into the new year, only to later continue the downward trend towards all time lows.  In fact, so far at least, the recent move is actually one of the least dramatic we have seen.  However, you wouldn’t know it from the increasing chorus of headlines declaring that the recent rise in rates signals an end to the “bond bubble”

Just because the market has done something in the past is certainly no reason to think that it is going to continue to do so.  However I do think it helps put the recent move higher in rates into perspective.

My 10 Year Treasury Rate Forecast

There is no doubt that with rates so low the risk is to the upside.  However, this has been the most euphoric start to the year that I remember since the financial crisis, and we have seen around a 25 basis point move in the 10 year treasury.  Since the mood of the market is already so elevated, I am skeptical that we are going to see things become a lot more euphoric in 2013 than they already are.

Although the situation here in the US and Europe has certainly improved, there are still many dangers lurking in the shadows.  While I hope I am wrong, I suspect that one of these dangers will rear its ugly head in the relatively near future, putting a near term cap on both stock prices and the 10 year treasury yield.

With this in mind I anticipate that we will likely spend 2013 bouncing between the 2.20% and 1.80% levels.  This means that while there will be some opportunities for traders, the long term investor is likely to find better value elsewhere.

For more reasons why I do not think there is a bond bubble go here.