Growth outlook leads rate hike

Obama's tax deal with the Republicans is causing a massive sell-off in bond markets across the globe. According to a Reuters report,

Benchmark 10-year yields reached as high as 3.33 percent going into the auction, which meant a whopping 40 basis points had been added since Monday's close,

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The benchmark 10-year U.S. Treasury note US10YT=RR was down 1-1/32, with the yield at 3.265 percent. The 2-year U.S. Treasury note US2YT=RR was down 6/32, with the yield at 0.624 percent. The 30-year U.S. Treasury bond US30YT=RR was down 1-9/32, with the yield at 4.453 percent.

There seem to be several reasons for the rate hike. First, the extension of the Bush tax cut could help boost the economic growth, especially by sustaining households still trapped in a devastating condition of housing markets. Second, some argues that the tax cut could lead to more deficit spending, hence slackening a balance between supply and demand in bond markets. Third, the Fed might end up buying fewer bonds than previously planned due to more bright prospect for the economy.

Those three factors are supposed to have had more or less combined effects on the plummet in bond markets. What's interesting is that the inflation expectation is constrained compared to the real interest rate which is rising almost in tandem with the nominal interest rate. The rise in the real interest rate could swell debt burden for private business sector, thus costing corporate investment. At least for now, fixed investment would play a minor role to drive the US economy.

In the meantime, Japan's third quarter GDP has just been revised upward, outpacing the US and Europe in the same period.

Gross domestic product grew at an annualized 4.5 percent rate in the three months ended Sept. 30, faster than the 3.9 percent reported last month, the Cabinet Office said today in Tokyo. In nominal terms, the economy grew 2.6 percent, less than the 2.9 percent earlier projected, as price declines deepened.

Private consumption, which accounts for about 60 percent of GDP, also fueled the expansion as households stepped up purchases of energy-efficient cars ahead of the expiration of a subsidy program. Japan's economy is now poised to contract this quarter because of slowing exports and an erosion in the outlook for corporate profits after the yen's surge.

The more the third quarter GDP grows, the less the fourth quarter grows given the household has already trimmed down its spending after the government subsidy to eco-friendly cars was over in September. The government has recently decided to infuse 5.1 trillion yen to the economy as an extra budget to counter a strong yen and deflation, adding up to 915 billion yen of stimulus package approved in September which was criticized as too small. Moreover, the Bank of Japan launched another monetary easing in November, supporting the government effort. But so far, the likelihood is increasing that Japan's economy falls back to a contraction this quarter after four successive quarters of growth.

At least, it looks like that underlying economic conditions verify the rise in the US interest rates.