Two-Year Treasury Yields Move Toward Zero, A Chance For More Stimulus

The drop in global stock markets, and fear of a rise in the financial troubles of Europe, and a belief that corporate earnings could be battered in the second half of the year has caused the cautious to seek American paper. There has also been a significant move into German and Japanese debt. All Treasury yields have fallen, as would be expected. Ten-year notes now yield as little as 2.9% and that may fall further as money flows into the instruments.

It is worth recalling that in December 2008, four money market funds yielded zero and among the 500 largest U.S. money-market funds, 41  have daily annualized yields at or less than .05%. The panic in the markets had driven money into that market although almost no one thought could ever be over-bought.

The Federal Reserve has a role in the pricing of “flight to safety” paper. It has continued to keep interest rates between zero and .25%. Cheap money is almost everywhere, although banks and business are often reluctant to use it as fears of another slowdown in the economy or a double-dip recession have continued.

The consistently low yield may tempt the Congress and the Administration to get back into the stimulus business. The $787 billion stimulus programs passed and signed into law early last year have only been marginally successful. There have been calls, mostly from White House economic advisers floating trial balloons, to pass a second stimulus. Congress has balked and will not even help 1.7 million Americans by extending unemployment benefits until November. The price tag of the legislation would be $33 billion, according to the CBO.  Members of Congress do not want to face their constituents in the mid-term elections just as they have added to the deficit.

The philosophical debate over whether austerity or stimulus is the better path to prosperity has become more raucous as large nations such as Germany and the UK make deep cuts in government spending.  Some reports say the UK government has told  cabinet members that their budgets could be cut 40%.  That will kick away most of the buttresses meant to support economic growth. Only a year ago, even the UK government believed that spending was the road to an economic turnaround.

The time is now, if the US government is to begin a new set of stimulus programs. Money is cheap, perhaps as cheap as it will ever be for the Treasury. The will of Congress is probably not great enough to take advantage of the current move of capital market money into American paper.

Economists would argue the an acceleration in the increase of US debt would drive US borrowing costs up. That is true unless the strong demand for Treasury debt continues in the short-term or even two or three years out. A successful stimulus package might improve the economy enough so that it could increase the tax base. The window for a second stimulus will probably have closed by then

Douglas A. McIntyre