Is bond selloff (and rate spike) due to economic improvement, profit taking, or over-supply?

Economists and traders are observing that it is hard to decide whether investors selling fixed-income securities (thus driving rates higher) because they expect US stimulus to boost growth in 2011, or whether they are bothered by the amount of current and future debt. Most admit that growth would be far more preferable than seeing yields rising due to people thinking that America’s fiscal situation being unsustainable.

Most believe that the economy is not strong enough to handle higher rates… but let’s not forget the budget and deficit problems that we face. Bloomberg tabulates that $38 billion in Federal aid will need to be replaced at the state level here in the US when the stimulus ends. “At least 31 states and Puerto Rico are forecasting deficits of $82.1 billion in the next fiscal year even as tax receipts are picking up.”

Since the beginning of November, Fannie 4’s (the MBS into which 4.25-4.625% mortgages are generally placed) are worse by more than 3 points. And it doesn’t take long for businesses based on refinances to see the slow-down. Yesterday’s 10-yr auction went ok (the old saying goes, “If you liked it at 2.75%, you’ll love it at 3.25%”), but rates are still higher. TradeWeb showed a heavier-than-normal MBS sales day, and Fannie 4’s printed their fourth “handle” this week as they dipped below 99.00.

This morning we had Initial Jobless Claims, probably the most important piece of data in what has otherwise been a pretty barren week. Claims are one of the best leading indicators of the labor market, and have ranged from 450k to 490k for most of the year although in the last month the moving average has dipped below 450k. As you can guess, consumer sentiment is very sensitive to the labor market, and how good or bad folks out there feel influence spending, GDP, and economic growth. Jobless Claims came in 421k, down 17k from last week’s revised number, and the 4-week moving average dropped 4k to about 427k.