The U.S. long bond yield is edging lower with each and every passing day, and now stands below 3.90%. At the same time, we cannot help but notice the huge gap that still exists between 10s and 30s — nearly 100 basis points. There is tremendous potential for a narrowing in this spread, as there is between the 115 basis point gap between 5s and 10s. The entire yield curve is primed for a bull flattener. And, if we are right on the deflation theme, then long duration on high-quality bonds would seem to make some sense. (There is still potential for lesser grade corporates, but the higher the risk, the lower the duration in the current economic backdrop.)
Still, we all tend to focus on the 10-year note given its deep liquidity and the fact that the mortgage market is priced off it. We bring this up because the Cleveland Fed just published a report on Estimates of Inflation Expectations, and based on our reading of where their numbers are on inflation expectations, the inflation risk premium and real rates, we stand a very good chance of seeing the yield on the 10-year note ultimately grind down to 1.9%. So, the answer is yes, we are likely to see new lows in U.S. Treasury yields occur across the curve before this bull market is over (after all, we are already there out to the two-year segment of the curve). Moreover, note that the 1.9% level would actually mark a fair-value yield — if this truly morphs into a bubble, we could be talking about market rates heading even lower than that.
That’s David Rosenberg’s lead-in to his daily market note (he released it tonight because tomorrow is a holiday in Canada). At least this is bullish for mortgage rates. I think we are at the end of the bull market in bonds. But that doesn’t mean there isn’t some upside left in the bond trade now that deflation is upon us.
In February, I posted a video of Louise Yamada saying that we are indeed in the death throes of bond bull market. But these are trends that take a long-time to progress:
She says, however, that bond market tops take 2 to 14 years to reverse trend.
Bottom line: bond market tops are usually associated with economic depression. And, unlike in bottoms when inflation is pushed ahead by high capacity utilization, deflation is the order of the day in bottoms. And that means low rates can last for quite a long time. Just ask the Japanese.
Dr. Bernanke better get the helicopters ready.
Source: Dinner with Dave: Market and Data Musings (pdf) – David Rosenberg, Gluskin Sheff
Also see Rosenberg: The Case For Bonds.