My recent asset class review focused on crude oil, gold, and the U.S. dollar. Now we take a look at U.S. Treasury yields.
Because Treasuries are insured by the U.S. government, they are considered a relative safe haven. Thus, in times of economic turmoil--such as we had in late 2008 and early 2009--we see active purchasing of Treasuries, which drives down their yields.
The two-year yields are sensitive to Federal Reserve policy--actual and anticipated; hence, they have stayed near 1% in response to continued Fed ease.
The ten-year yields (middle chart) and thirty-year yields (bottom chart) are sensitive to deflation, reflation, and inflation. They collapsed during the market turmoil--those safe yields were attractive to investors, leading them to snatch up longer-dated Treasuries--and now have bounced back significantly with easing of the crisis and reflation.
The result of the bounce in yields is a meaningfully steeper yield curve, which encourages lending by banks (who borrow cheap and lend dear). Indeed, the steepness (and steepening) of the curve has been a nice sentiment indicator for trader and investor perceptions of recovery. Fears of deflation (which drove the difference between thirty-year and two-year rates to around 2% during the height of the crisis) have abated; at the same time, longer-term yields are close to their mid-2008 levels and not pricing in unusual inflationary expectations.
Observe how yields bottomed in January ahead of stocks. We're also seeing an intermediate-term topping of yields, which have moved below their June peaks. I believe this is a possible lead signal of further anticipated weakness in the economy and topping in stocks. With the U.S. consumer still under the weather, disinflationary themes are every bit as much a concern as inflationary ones.
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3 comments:
Take into account of the seasonality of mid September through mid October being historically negative and treasuries topping 1-2 months before stocks, it presents an interesting situation ahead.
I've been thinking quite a lot about this phenomenon over the past week. Typically, as appetite for risk increases, stocks rise and treasuries sell off. Interest rates rise as fear dissipates, and thus, investors sell treasuries. Interest rates and treasury prices move inversely to each other.
The strange thing that is developing, however, over the past several days, is that the stock market has remained relatively strong (within a trading range at the top of the recent bull rally), which treasuries have RISEN, with interest rates near their lows of the past few months. This is unusual! I've been wondering how to interpret this change in wind direction.
You, Dr. Brett, appear to have hit on the correct interpretation. This rise in 10-year treasuries appears to be reflecting a resurgence in fear and a renewed flight to safety. This has some ominous implications suggestive of concern that the economy and/or stocks will take another dip. Only heaven knows for sure when or to what degree!
Thanks for the insight. This made a few things click in my mind today!
I think there is a tendency by traders to read too much into every little relationship between asset classes. Treasuries are range bound, stocks are rallying. Just because Treasuries made a lower high doesn't mean risk appetites have diminished and stocks will go therefore go down, it just means that the treasury market is weak right now. to extrapolate anything to stocks is a leap of faith I can't take yet.
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