THE BLOG

How High Will Interest Rates Go?

07/09/2013 09:53 am ET | Updated Sep 08, 2013

To best answer the question as to where U.S. Treasury yields are headed in the next quarter or two, it is important to know where they would be without the manipulation of our central bank, where they would be in a growing economy and, also, absent the threat from an imminent collapse of a major foreign currency. The current yield on the Ten-Year Note is 2.6 percent, up from 1.6 percent less than two months ago. True, that rate has surged of late but it is still far below its 40-year average of around 7 percent. But just prior to the beginning of the Great Recession (in fall of 2007) the yield on the Ten-Year Note was 4 percent -- 140 basis points higher than today.

And in the spring of 2010; a year after the recession ended, the conclusion of QEI and prior to the Greek bailout, the Ten-Year posted a yield of 3.8 percent. Therefore, it isn't at all a stretch to anticipate yields going back toward 4 percent in the very near future -- If indeed it is true that we are not currently in a recession, the Fed will soon start to winding down QE and there is no mass piling into Treasuries from a collapsing foreign currency.

What's more, the Fed now holds over $3.5 trillion worth of securities on its balance sheet, $1.9 trillion of which are U.S. Treasuries. That compares with just $800 billion at the start of 2008. This means if the market now believes the Fed has started down the path of eventually unwinding its balance sheet the selling pressure will be immensely magnified as compared to several years ago. In addition, due to banking distress in China and a back up in yields in Japan, these sovereign governments may not be able to support Treasury prices to the same extent as they did in the past. These two nations already own $2.3 trillion of the current outstanding $11.9 trillion worth of Treasury debt.

Meanwhile, the Fed persists in sophomoric fashion to scold the market for misinterpreting its mixed messages about tapering the amount of asset purchases. But the big surprise for Mr. Bernanke and co. will be the realization that they have much less control of long term rates than they now believe.

I've been on record warning that once the market perceives the exit for QE is near, yields will rise. Nevertheless, expect most on Wall Street to claim the increase in rates has its basis in a growing economy and, therefore, represents good news for markets. But the true fallout from interest rate normalization will not be pretty; for it will reveal a banking system and an economy that is perilously close to insolvency.

Michael Pento is the President and Founder of Pento Portfolio Strategies and Author of the book "The Coming Bond Market Collapse."