Traders in the 10-year bond options pit at the Chicago Board of Trade signal orders.
Frank Polich | Reuters
A key interest rate is moving to levels last seen in the fall when markets were worried about the trade war, and that falling yield may be a warning signal.
Investors have been buying bonds big time this week amid fears the coronavirus could spread and impact the global economy. Yields move opposite price, so as investors jumped in, the 10-year note yield has dipped to 1.68%, its lowest level since the beginning of November, and it could keep moving lower.
In the past week, the yield has fallen from 1.83%, as investors fear the virus could have an immediate impact on the economy in China and broader Asia, and then ultimately chill global growth. The 10-year is important since it influences a whole slew of loans, including home mortgages.
But the spread of the virus, which has shut down transportation in Wuhan and other Chinese cities just as the Chinese new year begins isn’t the only factor weighing on bond yields.
“The question is what’s the economy going to do this year, and I think right now the 10-year note is saying we don’t really know, but given what we’ve seen in 2020, it’s telling us we should hedge the other way,” said Gregory Faranello, head of U.S. rates at AmeriVet Securities. The softness in recent labor data and lack of inflation have also been factors, and Faranello said there are concerns that Boeing’s problems could crimp U.S. GDP growth, as it cuts back on production.
Some strategists say the Fed and other central banks may be having an even bigger impact on rates and seem to be sending investors into bonds and stocks at the same time. Stocks were lower Friday on concerns about the coronavirus, but all three major stock indices are just about 1% below their recent highs.
“We’re at the low end of a recent range [on yields]. It’s a number of factors. One is the broad fundamentals that we entered the year with are more firmly entrenched,” said Mark Cabana, head of U.S. short rate strategy at BofA Securities.
“You have global central banks on hold. You have a growth and inflation environment which is relatively benign. We’re not in a recession and won’t be any time soon.”
Investors have been bidding both corporate credit and stocks higher since the start of the year. “You also have an environment in which risky assets have done well,” Cabana said. “There appears to be a thirst for yield happening across asset classes. There is still a very powerful need for duration from the insurance and pension community.”
Many strategists had expected Treasury yields to move higher this year, just as stocks did, in part because of improved prospects for the economy due to the trade deal signed by the U.S. and China.
“That grind lower we’ve seen in rates so far this year, indicates there’s a little bit of a pain trade from some who thought rates were going higher,” said Jon Hill, senior rate strategist at BMO.
BMO strategists say a case can be made for the 10-year to fall back down to 1.427%, a level it reached in late August. After the current level, the next technical area lower would be 1.668%, an intraday low from the beginning of November. Then September’s low yield of 1.503% could be in play, and after that the yield could head into the 1.40s.
The Fed is not expected to take action when it meets next week, but it is expected to signal it will continue to hold rates low and won’t move on policy anytime soon. Fed Chair Jerome Powell is expected to reinforce that the Fed plans to continue building up its balance sheet with Treasury bill purchases for a while longer. Both of those things could keep pressure on yields.
The combination of the Fed’s easy policy and those of other central banks has made U.S. assets particularly attractive. While the Fed keeps interest rates low, bankers in Europe and Japan have negative yields, and that is another factor pushing investors into the U.S. bond market—and also stocks.
“That’s been the question on the table. Which market is right? Is the bond market saying one thing and the stock market saying another thing? That’s the tug of war,” said Faranello. “To me it goes back to central bank liquidity, and the market is flooded with a ton liquidity and that liquidity needs to flow somewhere. Are they saying the same thing? I think they are.”
Hill said the diversion between stocks and bonds is notable, as stocks headed to highs recently. “I think the bond market is listening to a combination of the data and the Fed. The data is suggesting that even after a phase one trade deal, even after 75 basis points in rate cuts from the Fed, the U.S. economy still faces headwinds,” he said. “They may be less than before, but they’re still substantial.”
Hill said the central banks have been emphasizing that rates aren’t moving higher any time soon. “It’s going to be hard for the 10-year yield to return to 2% unless a large component of that trade is reflation.” So far, there’s no sign inflation is picking up to the Fed’s 2% target, so rates may not move out of their current 1.50% to 2% range any time soon, some strategists say.
However, Jim Caron, portfolio manager at Morgan Stanley Investment Management, said he thinks the 10-year is reflecting worry about the coronavirus more than other factors.
“I think it’s a reaction to the coronavirus,” he said. “Most people think global growth is going to be stable and go up a little bit…I think the downside yield is limited. Right now it’s hard to put a number on it. It’s more of a hedge. If I want to own equities, but I’m a little worried, then I want to own Treasurys too.”