"There was a sizable sell off in US Treasuries late last week — 10-year yields rose by over 30bp from a low of 2.84%. Some of this selling reflected an unwinding of safe-haven flows following the Greek government’s successful passage of tough new austerity measures. There are a couple of other explanations as to why bond yields have moved higher. First, the recent slowing in US economic activity has likely seen the bond market overly pessimistic about US growth prospects, in our opinion. Indeed, over time 10-year Treasury yields tend to track expectations about future (nominal) GDP growth. Bond yields slipped below 3.0% last week. This seems out of line with even the most pessimistic expectations about GDP growth. Second, data last week show that inflation pressures are, if anything, picking up. The core PCE deflator (the one watched by the FOMC) rose by 0.3% m/m, the largest monthly increase since October 2009. On an annual basis the core PCE is 1.2% y/y up from its low of 0.7% y/y at the end of 2010. In addition, a closely watched measure of medium-term inflation expectations (the 5-year/5-year swap rate) has picked up notably recently. Falling bond yields are inconsistent with rising inflation and inflation expectations, at least over any reasonable period of time."
