Hemera Technologies
The yield on the U.S. 10-year Treasury bond – the most important benchmark for bonds in the world – slumped below 2 per cent for the first time in history Thursday, as another wave of startlingly weak economic data forced traders to come to grips with the fast-eroding prospects for the U.S. and global economy.
The yield on the 10-year notes hit a record low of 1.97 per cent in morning trading, following the announcement that the Philadelphia Fed Index, an important regional indicator of U.S. manufacturing activity, had taken a shocking downturn to its lowest level since the March, 2009, depths of the recession. The benchmark bond ended the day at 2.06 per cent, just above its record-low close of 2.05 per cent in December, 2008.
The day began with yields drifting lower as a new round of European bank fears sent investors scurrying for the safety of U.S. government paper, but traders said the prompt reaction to the Philly Fed stunner demonstrated that worry over the economy is now the primary driver of bond yields. The market is pricing in expectations that the U.S. economy is faltering and likely faces a long, slow recovery that could take years.
"Ten-year Treasuries are already discounting a mild recession," wrote Goldman Sachs chief interest rate strategist Francesco Garzarelli in a research note.
"The market has swung around to this view in light of the economic news, which has been very disappointing," said John Higgins, senior markets economist at Capital Economics in London.
"People are concerned that policy makers just don't have the tools to do anything about it … they've used up most of their ammunition," he said. "Therefore, the prospects remain bleak – even if they don't slip into a recession."
Market watchers noted that 10-year Treasury inflation-protected securities (TIPS) – which reflect "real" bond yields, after removing inflation expectations – dipped into negative territory during the day, meaning that investors are essentially paying for the privilege of lending money to the U.S. government.
"There's been a collapse in real yields," said Jim Gilliland, head of fixed income at Leith Wheeler Investment Counsel Ltd. in Vancouver. He said the near-zero yields along the U.S. government yield curve, even for bonds maturing in five years' time, indicates that the market expects the U.S. Federal Reserve Board to barely raise its key policy-setting Federal Funds interest rate over the next half-decade, as persistent sluggish growth and a weak job market keep it inactive.
"The capacity gap is going to take a very long time to [reach]full employment," he said.
The U.S. downdraft helped pull the yield on 10-year Government of Canada bonds to a record low of 2.29 per cent. Mr. Gilliland believes yields on Canada bonds, particularly those maturing in three to five years, are now too low, given this country's superior economic prospects.
"The market is over-discounting the impact [on Canada]of the slower [U.S.]growth outlook," he said.
Low interest rates are generally considered a positive for stock markets because they keep down corporate borrowing costs and make stock returns look attractive relative to bonds. Mr. Higgins warned, however, that assuming any boost to stocks would be a "simplistic conclusion," given the economic uncertainty hanging over global markets.
"If you think low bond yields are a trigger for equities, just have a look at Japan," he said.
While he doesn't think the U.S. economy and markets are in as dire a condition as Japan was in the 1990s, he does see one key similarity: A growing lack of confidence that the government and the central bank can act to stop the bleeding.
"With the passage of time, people have seen a huge amount of [stimulus]money poured into the U.S. economy, but they haven't seen a lot of bang for their buck," he said. "Weak economy and weak ability to respond – that's not a recipe for a strong stock market."
David Parkinson