Weekly Market Compass: What’s driving low Treasury yields?
Last week, we saw yields on US Treasuries reach fresh multi-month lows. The 10-year yield fell to 1.25% during the week, although it was able to finish the week modestly higher.1 Even the 30-year US Treasury fell through the 2% level late last week.2 I grew up in this industry believing that the 10-year yield is a better gauge of fear than the VIX, so I believe it is important to pay attention to the 10-year yield — and try to understand why it has fallen so much.
Reason 1: Rising COVID cases
One obvious reason is COVID-19. Cases are rising in some parts of the world — and some parts of the United States. Those who think this isn’t a big reason for the drop in yields just aren’t looking at the statistics closely:
- On July 11, Australia reported the highest daily total of new COVID-19 cases in more than a year.3 While only 112 cases were reported that day, it is still a cause for concern given that daily cases have been rising and only about 10% of the adult population in Australia is vaccinated.
- Indonesia is seeing a large spike in new COVID-19 cases — and new deaths — last week it hit records for the number of new cases and deaths.4 As a result, the government has urged regional leaders to impose stringency measures to stop the spread of the pandemic restrictions. Also, new daily cases in Cambodia, Myanmar, Thailand, and Vietnam are breaking records.5 What’s particularly disturbing is that this is a region that managed the initial wave of COVID-19 relatively well — as did Australia — so it is concerning that it is having far more difficulty with this wave (likely because the Delta variant is far more contagious).
- There were more than 20,000 daily COVID-19 cases recorded in the United States over the four-day period starting July 7, according to data from the Centers for Disease Control and Prevention (CDC). This is a large increase over the previous week.6 Cases are on the rise as the Delta variant spreads, and we are hearing concerning anecdotal information about COVID-19 causing serious illness in younger people in their 30s, 40s, and 50s. CDC Director Rochelle Walensky said that it appears two Americas are emerging, with two different trajectories, depending on vaccination levels: “These numbers and what we are seeing across the country reveal two truths about the current state of the pandemic. On the one hand, we have seen the successes of our vaccination program over the last eight months, with cases, hospitalizations, and deaths far lower than the peaks we saw in January. And yet, on the other hand, we are starting to see some new and concerning trends. Simply put, in areas of low vaccination coverage, cases and hospitalizations are up.”7
- Japan announced that no spectators would be allowed at the Tokyo Olympics — a shocking and economically damaging development caused by a surge in COVID-19 infections.
Reason 2: Slowing growth expectations
We have seen a strong economic recovery in many parts of the world, but there are fears that the spread of COVID-19 could easily lead to the imposition of new restrictions that slow the economy. Last week, the European Commission upwardly revised its estimates for eurozone growth this year but warned that new variants of the coronavirus could lead to such restrictions.
But even now, without new restrictions in place, we are starting to see small signs of a slowdown:
- The Institute for Supply Management June service sector reading clocked in below expectations, at 60.1 — well below its prior reading of 64.0.8
- Weekly initial US jobless claims rose to 373,000, up slightly from the prior week but moving in the wrong direction and worse than expected.9
- There also seem to be concerns that a global minimum tax could put a damper on growth.
Having said that, I think the greatest concerns about global growth (beyond COVID-19) relate to worries about a central bank policy error — that central banks may start raising rates sooner than early 2023. St. Louis Fed President James Bullard hinted at a possible policy change for the Fed in mid-2022, and so has European Central Bank President Christine Lagarde.
Reason 3: Less concern about inflation
Markets seem to have largely come around to the view that higher inflation is in fact transitory. Not only is the Federal Reserve reinforcing that view at every turn — in both the Federal Open Market Committee meeting minutes from June and the Fed’s semi-annual report to Congress released last Friday, the Fed continues to describe higher inflation as “transitory” — but investors are believing them.
University of Michigan consumer inflation expectations for the year ahead dropped from 4.6% in May to a still-high 4.2% in June.10 However, inflation expectations for the 5-year period fell from 3% to a far more tame 2.8%.10 One factor likely shaping that view is the realization that fiscal stimulus may not be very abundant going forward — just look at how difficult it has been for the US to get an infrastructure bill passed despite the fact that it is an issue that garners bipartisan support.
Reason 4: Excess demand for Treasuries
It’s also possible that the high demand for Treasuries is simply a function of a desire for diversification and yield. The second year of a bull market can be more challenging and volatile than the first, and some investors may want to gain exposure to Treasuries at the same time much of their portfolio is comprised of risk assets, especially given the risks created by COVID-19 variants. In other words, the bulk of one’s portfolio might be positioned for our base case scenario, which is quite positive and anticipates risk assets may outperform, while a small portion of some portfolios may be positioned for something more akin to our “pandemic resurgence” scenario. I also believe there is still strong demand for the yield offered by US Treasuries, as it is still relatively high compared to developed market sovereign bond alternatives.
In conclusion, I think it’s important to stress that this is not 2020 — effective vaccines have been developed and have been shown to be effective against all currently known variants of COVID-19. That’s why spreads are tight and the 10-year yield is not at 0.5%. However, the dramatic differences in vaccination levels among countries and local areas suggests there will be different speeds to economic recoveries — and raises the risk that worse variants will develop. And there are certainly other risks, such as a possible central bank policy error, that is weighing down yields. Having said all that, I remain positive that the 10-year yield should rise later this year, especially once tapering begins.
We will of course want to follow vaccination progress and the spread of COVID-19 variants very closely. I will also be keenly interested in Fed Chair Jay Powell’s Humphrey-Hawkins testimony to Congress this week. Powell might provide clues as to when he thinks the earliest could be that rate hikes might begin. I believe a rate hike in mid-2022 is very unlikely but — if it does happen — it would be because the economy no longer needs such excessive accommodation. Finally, the start of earnings season is coming up. A very strong earnings season should come as no surprise, so I will be focused on guidance about future earnings.
1 Source: Bloomberg, L.P.
2 Source: Bloomberg, L.P.
3 Source: The Financial Times, “Australia reports highest daily cases total in a year,” July 11, 2021
4 Source: The Economist, “A wave of covid-19 is engulfing Indonesia,” July 11, 2021
5 Source: The Economist, “A wave of covid-19 is engulfing Indonesia,” July 11, 2021
6 Source: Business Insider, “The US recorded more than 20,000 new COVID-19 cases each of the past four days as the Delta variant spreads,” July 10, 2021
7 Source: The White House, press briefing July 8, 2021
8 Source: Institute for Supply Management, July 6, 2021
9 Source: Department of Labor, July 8, 2021
10 Source: University of Michigan, “Stronger economy anticipated amid appreciable risks,” June 25, 2021
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The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility.
The opinions referenced above are those of the author as of July 12, 2021. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.