Interest rates on U.S. Treasury bonds climbed today. The 10-year bill yield jumped 5.25% to 3.65%.

Rising yields could spell disaster for the U.S. recovery. Here’s why…

CNNMoney’s Catherine Clifford writes, “Treasurys are considered one of the safest places to keep funds and so are in high demand in times of uncertainty. When the economy is on the upswing, however, investors are lured out of the safety of Uncle Sam’s debt and into other, higher yielding and higher risk assets.”

So far, so good… When the U.S. and global economies were in turmoil, cash flooded into U.S. Treasuries. That pushed yields down – and prices up.

Treasuries looked like the answer to stoking a recovery.

And it works, a little. Commodity prices are on the rise, U.S. and global markets are rallying.

But that means less interest in U.S. Treasuries. Less demand lowers prices and raises yields… Which may be good for investors, but means the government would have to shell out more money to bondholders in the long run.

And since mortgage rates and other loan rates – including auto loans and credit cards – adjust according to these yields, higher yields means the cost of borrowing climbs.

That could derail the economic recovery.

The U.S. government just held an auction for $101 billion in Treasury notes last week, however, and Bloomberg reports, “The bond market shows international demand for American financial assets is as high as ever, even as the dollar slides and the U.S. deficit expands.”

And The Wall Street Journal’s Jonathan Weisman writes, “On Thursday, the Treasury Department is expected to announce an auction of roughly $65 billion in three-year, 10-year and 30-year notes and bonds, and the result will be closely watched.”

But it’s a delicate balance, and one that has the U.S. government dancing.

Adam Lass, editor of WaveStrength Options Weekly, says, “Now the last thing in the world Washington wants is for rates to go up just as a little mini boomlet in used-house sales is coming along. So, in order to quell this brewing bondholder rebellion, the Federal Reserve has kindly offered to buy up any notes the Treasury department can’t flog at their little flea market.”

So what it can’t sell at its auctions, the government has indicated that it might be willing to buy them itself.

In fact, MarketWatch reports that an RBS Securities survey showed that 90% of bond market participants “believe the Fed will buy more securities and 67% said the Fed would take the step at their next formal meeting on June 23 and 24.”

Adam retorts, “I am assured by more than one professional economist that robbing Peter to pay Paul is a perfectly legitimate fiscal plan. But personally, it sounds to me like a giant check-kiting scheme. Or perhaps the grandest three-card Monte scam in human history.”

That means the whole house of cards could come crashing down. Adam says that there’s a rumor floating around that the U.S. will lose its AAA credit rating. The U.S. has been AAA-rated since 1917. Through the Depression, through the New Deal, through the introduction of welfare, the loss of the gold standard, inflation at 14%, and the biggest deficits (by GDP) and the biggest dollar deficit, says Adam in Taipan Daily.

“Unfortunately, it appears that this is exactly the road Washington is headed down as fast as its million little feet can carry it. When our credit gets downgraded, it will become more expensive to raise money. But don’t expect Washington to tighten its belt,” Adam warns.

Just the opposite…

“Rather, they will react by printing more and borrowing more simply to service this enormous debt.”

So the true cost of keeping Treasury yields low – and therefore the cost of consumer borrowing low – will mean hyperinflation down the road, and the destruction of the U.S. dollar.

“I suspect,” says Adam, “it is still a good bet to hedge any and all dollar-denominated assets.”

Other Related Topics: Sara Nunnally , Taipan Insider , U.S. Dollar , US Treasury

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