Real yields on US Treasuries fell to the lowest level since 2012 this week in a move that reflects the belief that a weak economy will need loose monetary policy for a long time — and which helps explain why equity markets are near-record levels despite the gloomy outlook.
Real yields, which strip out expected inflation from the actual yield on sovereign bonds, have plunged around the world as central banks have cut rates and unleashed monetary stimulus to limit the economic fallout from the coronavirus pandemic.
Investors attributed the latest leg down in the US to expectations that the Federal Reserve would be prodded to do more to shore up the economy, following signs an economic rebound is stalling.
“Low real yields represent a barometer for liquidity being injected into the market,” said Jim Caron, a senior portfolio manager at Morgan Stanley Investment Management, who added that they prompt investors to search out other sources of income.
“It is no doubt supportive for financial assets and supportive for growth,” he said.
The Fed’s decision to slash interest rates to zero in March and announce emergency measures has already helped spur a broad-based rebound across equity and fixed-income markets as investors put money into riskier assets.
That, in turn, has aided companies that need to raise money to see them through the pandemic and boosting the wealth of equity owners.
The S&P 500 is now positive for the year, while the tech-heavy Nasdaq Composite has hit record highs.
The slide in real yields has accelerated in recent weeks and comes despite little change in the nominal yield on the 10-year Treasury, which yielded 0.59 per cent on Wednesday.
The real yield on the 10-year Treasury, however, settled at minus 0.92 per cent, a level last recorded in the aftermath of the eurozone debt crisis nearly eight years ago. Such an extreme reading has only once been seen on an intraday basis in the past eight years, at the depth of the market turmoil in March this year.
In June, Jay Powell, Fed chairman, said he was “not even thinking about thinking about raising rates”. Other Fed officials have echoed his dovish stance ahead of the central bank’s next meeting at the end of July.
Scott DiMaggio, co-head of fixed income at AllianceBernstein, said the current level of real yields suggested investors believed the Fed would do more. “Central banks are doing everything they can to push down nominal yields in hopes that . . . they will pump up growth.”
Additional support was likely to be necessary, said Margaret Kerins, head of fixed income strategy at BMO Capital Markets, given that the recovery was set to be “long and protracted” with “no inflation fears”.
Market measures have reflected investor views that inflation will be at most mild in the years to come. The 10-year break-even rate, which is derived from Treasury inflation-protected securities, was just 1.47 per cent on Wednesday.
Fed policymakers have embraced the idea of allowing inflation to rise above their 2 per cent target in a bid to bolster economic activity. They have also debated so-called yield curve control, where the Fed caps rates, as well as more explicit forward guidance.
“The Fed is unapologetic about what they are doing,” said Mr Caron at Morgan Stanley Investment Management. “They are saying, ‘we need to do more’.”