Below is a chart of the ten-year Treasury yield over the last three months. After peaking near 4% in April, it has since dropped to below 3% and currently yields for 2.97%. This is as abrupt a move as you are likely to see in long-term interest rates.
On the one hand, this is certainly a boon for mortgage rates which are at record lows, making the servicing of mortgage debt less expensive. However, the low rates are reflective of expected future interest rates – and to the degree they are low, this reflects bond market players’ concern about future economic growth.
Randall Forsyth points out that many economists are still pointing to higher yields despite this aggressive move to the downside.
Investors have contracted to lend to the U.S. government at returns so low as to be unimaginable just a few months ago. For instance, it was only three months ago that it was confidently asserted those returns had nowhere to go but up.
But on Monday, Treasury note and bond yields were knocking on psychologically important round numbers. The 10-year Treasury note hovered just above 3%, the lowest since late April of 2009. Meanwhile, the 30-year long bond was just above 4%, a level that hadn’t been revisited since early last October.
Further in the yield curve, the five-year note already had broken through the 2% barrier last week. The three-year note yielded only a bit more than 1%. And the two-year note — the Treasury maturity most sensitive to expectations about the future of short-term interest rates — traded at 0.63%, a trivial margin over the 0.60% low touched in the darkest days of the financial crisis in December 2008.
And yet, economists I polled for the Current Yield column in this week’s paper edition of Barron’s hewed to the current status quo. The Federal Reserve may lift its federal-funds target sometime in 2011 while the benchmark 10-year Treasury note yield may climb back to the high end of its recent range.
I think they are wrong. There is no inflation on the horizon in the United States. Wait until the helicopter drops and then you might get inflation. Right now, deflation reigns supreme.
I may have been early in saying sell equities to reinvest the money in gold or bonds or downside protection, but this view is being validated by the markets.
Update: David Rosenberg chips in with a few comments of his own:
For the record, the yield on the U.S. two-year note closed at a record low yesterday, at 0.625%. Think about that, we are supposedly in the first year of a reflationary economic expansion, and the two-year note yield has fallen to an all-time low. The 5-year note is down to 1.83%; the 10-year is at 3.02%; and the long bond is 4% on the nose. These are all new closing lows since the economic recovery began a year ago.
Yield activity will likely remain pressured to the downside. How can all the portfolio managers who are underweight the Treasury market show how short of a duration they are ahead of the quarter-end? Moreover, the net speculative short position by the non-commercial accounts on the Chicago Board of Trade (CBOT) is still massive at nearly 109,000 contracts on the 10-year note; although down from nearly 270,000 net shorts back in mid-April…
Moreover, this current down-move in yields is not happening on some TARP-related panic or talk of Armageddon, but on a growing realization that deflation, at least of a mild nature as it pertains to the Consumer Price Index (CPI), is inevitable. This is an economic event, not some technical or panic-related event like we had in December 2008… So, we had bank bailouts, stress tests, accounting changes, massive fiscal stimulus, housing assistance across a variety of fronts, and a huge expansion of the Fed balance sheet.
If we are wrong on the direction of market rates from here, it is because Uncle Sam has another rabbit to be pulled out of his hat. However, without some major exogenous positive shock, slower economic growth and mounting deflationary pressures will be the order of day.