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Biggest Treasury Bear Still Sees Fed in Control

NEW YORK (TheStreet) -- His call for 10-year U.S. Treasury yields to hit 3.76% by year-end makes him the most bearish bond forecaster in a Bloomberg survey of 71 market economists, but even Parsec Financial chief economist Jim Smith sees the Federal Reserve largely in control of long-term interest rates.

I called Smith because I was looking for someone to tell me a scary story about an imminent spike in long-term interest rates, but he doesn't sound especially alarmed. In fact, after I spoke with him last week, he lowered his forecast from 4.11% to the current 3.76%.

Smith explained that his forecast is based largely on studies that have shown "long-term interest rates in most developed countries typically are about 300 basis points [3%] above anticipated long-term inflation. If you anticipate we might be in for low inflation over the long term of around 1% then 'normal' 10-year Treasury rates ought to be around 4%," he says.

Still, Smith finds it difficult if not impossible to imagine interest rates could rise from their current levels to even as high as 4% in a period of a few days. My original question to him was whether he could see them jumping from current levels to 6%.

"For that to happen you'd have to have an earthquake devastate Hawaii and start moving toward California," he said.

I didn't understand why a simple market panic wouldn't do the trick. As this popular skit explains, markets are all about sentiment, so if sentiment can cause a stock market crash in a single day, why can't bond markets do the same thing?

"It's certainly possible," Smith acknowledges, "but never -- whats the Wall Street saying? 'Never fight the Fed.' They can stop that kind of panic in its tracks," he says.

This from the most bearish of 71 Treasury forecasters.

And still, everyone from Berkshire Hathaway Chairman Warren Buffett to former Fed Governor Frederic Mishkin has warned of a massive bubble in U.S. Treasuries. Hedge fund managers such as David Einhorn and Stanley Druckenmiller have warned about a Treasury bubble as well, according to a recent article by ProPublica's Jesse Eisinger, though I could find no evidence of this. Certainly those hedge fund managers have been sharply critical of the Fed's easy money policies, but I didn't see them warning about a bond bubble. Maybe they did.

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