(Photo: REUTERS / Brendan McDermid)
Traders work on the floor of the New York Stock Exchange, April 12, 2010.
Long-term bond yields have been dropping since early April as U.S. stocks have also weakened, amidst a backdrop of increased worries over European sovereign debt and signs of a weak recovery in the U.S.
Even when stocks have staged short-term rallies, Treasury yields still have not risen, suggesting something may be amiss.
For example, from the closing lows of June 7 through June 22, the S&P 500 stock index climbed about 4.3%. Meanwhile, the yield on the 10-Year Treasury hardly moved – in fact, it edged down a bit from 3.184% to 3.166%.
“We think this hesitation reflects skepticism in the bond market regarding the strength of the economic recovery, with jobs and housing of particular concern,” Sam Stovall, chief investment strategist at S&P. “In light of consensus expectations for strong, double-digit … earnings growth through year-end 2011, we believe this divergence bears watching.”
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The current atmosphere of low Treasury yields reflects the same flight-to safety that markets witnessed in late 2008 and early 2009.
“Global investors are looking for a safe harbor and they view the U.S. as such,” said Timothy Courtney, chief investment officer at Burns Advisory Group.
“Money flows continue to show that over the last couple of years investors are yanking money out of stocks and putting much of that money in bonds. At these low yields, whether they are cognizant of it or not, investors are not only pessimistic, but are betting against an economic recovery.”
The only way an investor can justify a 3.00% yield on the 10-year Treasury is to hope that the economy stays weak and rates stay low for a decade.
“Even then, after taxes and inflation, an investor is looking at a 0% real return at best,” Courtney noted. “If there is a recovery and/or rates do rise, real returns will be much worse and opportunity costs will be huge.”
Ironically, rates may rise even if we don’t have a recovery if investors begin to feel that U.S. government debt cannot be sustained, Courtney added.
Ari Wald, an equity analyst at Brown Brothers Harriman, thinks it would be quite concerning if 10-year yield fell to new lows, particularly below the psychological 3.00% floor.
“Markets would then be screaming to us at this point that things are not right and possibly be a sign of further weakness to be expected in equities as well,” he noted.
The three most important factors that are driving US Treasury yields lower, said Alan Gayle, senior investment strategist at Ridgeworth Investments, are risk-aversion, low inflation, and an easy Fed policy, with risk aversion likely the most dominant factor now.
James Cox, managing partner of Harris Financial Group, believes the Treasury yield will eventually rise, perhaps later this year, but for now the low yield likely reflects the fact that bank lending has receded.
“There is still a lack of lending in the private sector,” he said. “And funds are just being recycled through the Treasury markets. The low yields also indicate that many investors are generally fearful about how sluggish and terribly uneven the global economic recovery will be”
Indeed, U.S. Treasuries are probably viewed as the very safest investment possible (aside from gold), given how the news of austerity programs and budget deficits in UK and Europe seem to worsen by the day – thereby, driving yields to extreme lows.
However, if economic growth in the U.S. achieves some traction in the second half of the year and inflation starts to climb (as many observers expect), Treasuries would become less attractive and yields would move up again, i.e., revert to more normal levels.
Of course, in tandem, the debt crisis in Europe and the jobs picture in the U.S. would also have to show some signs of improvement by then.
“Yields are historically low and are near the bottom of the recent trading range, so going significantly lower might be challenging,”said Gayle.
“The key remains the market’s appetite for risk; if the EU debt situation is perceived as stable or the US economy shows signs of re-acceleration, investors would likely move back away from Treasuries and send yields higher.”
This article is copyrighted by International Business Times, the business news leader