Is it time to get bearish on bonds?

It's been about three weeks since the Federal Reserve announced its plan to buy $300 billion across the spectrum of maturities of government bonds. On the one hand the dollar reeled on the news of the onset of quantitative easing, while on the other the yield on the benchmark 10-year treasury note slid from 3% to 2.5% in the space of a day.

The notion was that the Fed's printing press was hard at work and while the attempt to drive yields down might spur lending it would ultimately monetize the nation's debt and drive inflation higher. And therein lies the problem. The Fed is on the one hand issuing gobs of debt on behalf of the U.S. Treasury, while on the other it is beavering away as it buys back smaller amounts.

So it's no surprise to learn that yields have practically given back all that they gained at the time of the announcement and have risen as high as 2.93% last week. The Fed will purchase on average $12 billion of various maturities over the course of the nest month. At the same time it will issue some $50 billion. Sure it's consistent, but the real question is over the effectiveness of its policy.

The Bank of England has seen the euphoria over lower gilt yields lost as investors try to understand the muddle and rates in the United Kingdom have risen by half of one percent since the Bank's announcement.

How do investors measure the effectiveness of quantitative easing anyway? The aim of what central banks are trying to do in this phase of economic quagmire is spur lending by pushing interest rates lower, undermining the appeal of the perceived safety of government paper and gradually encouraging investors to step back into corporate paper and ease the burden on companies who are currently laying off workers to cut costs.

It is therefore arguable that witnessing lower yields as a measure of the success of the program is actually a reverse indicator. After all, how many investors would rather see lower borrowing costs and weaker stock prices? It's preferable that a self-sustaining recovery pushes yields higher as investor confidence comes back and investors prefer to bank on a rebound in stocks. However, a rising stock market is seen as a huge signal of a turning point in economic fortunes. Stock markets tend to discount economic recovery by around six months and so the current rally is helping to put egg on the face of the FOMC in its quantitative easing plans, despite the fact that without the announcement the stock market might be less rather than more robust.

So far, 10-year yields have remained beneath 3%, but we're starting to wonder whether the relatively small scale of the program coupled with investors desire to discount recovery will ultimately send yields on an excursion above 3% in coming weeks.

There seems precious little point in pretending that the Fed's plans to buy $300 billion of government debt actually matters when the treasury will end of issuing $2.5 trillion this year.

If yields rise when faced with ongoing monthly surges in unemployment, there seems nothing standing in the way of a weaker bond market when the whiff of inflation remains a lingering prospect. We need to consider the prospects for a break down in bond prices and a period of above 3% yields. Bond investors will prod the Fed into action to see how they respond to the perception that the plot is up.

The Supreme Council of the Secret Order of Jurojin