About five months ago in Dent Digest Trader, I observed that rates were declining on continued weakness in the U.S. economy, but wondered just how low they could go. I concluded that yields had the potential to drop quite a bit further.
I was looking at mid-December, when our 10-year Treasury note hit a low yield of 2.12%. At that time, the German equivalent yielded just 0.66% and the French 10-year was 0.93%.
It turns out I was right. It didn’t take long for our 10-year Treasury to fall to a yield of just 1.65% by the end of January 2015.
But it wasn’t just us. The German Bund fell all the way to 0.15% and was expected to go negative like the Swiss 10-year.
Note the pattern here. We’re watching a global phenomenon unfold. This is not just America’s story.
Even though the Fed ended QE in October of 2014, Europe was starting theirs, Japan never quit, and even China started easing. That caused U.S. rates to move lower.
U.S. interest rates did move higher after the Fed announced a possible hike as early as June. But they fell again after Europe announced their own QE, China announced theirs, and we reported weak first quarter economic data here at home.
So, just a few weeks ago, many analysts forecast new record low yields as Treasury bonds traded in a narrow range and volatility disappeared.
Market participants finally woke up to reality. They saw too much risk in buying overpriced debt that had little chance of further appreciation (lower yields). For the last couple weeks, bonds around the world have started to sell off, causing yields to rise quickly. See chart below.
CBOE Interest Rate 10-Year Treasury
The U.S. 10-year yield has climbed 33 basis points and to a five month high of 2.25%, the German bund is higher by 39 basis points at a whopping 0.59%, and even Switzerland is out of negative yield territory!
These are negative directions for yields, and they don’t speak well of the Fed and other central banks. When the Fed raises rates, it’s meant to slow down inflation and an overheated economy… when yields rise due to investor perceptions, it’s not a good thing. It means investors are scared, and the markets know it.
Even worse, rising yields could trigger a stock market exodus as well. Those who flee to the safety of bonds would normally cause yields to fall back down… but in the last crash, bond prices and stocks fell while only the U.S. dollar rose.
So, we have to ask: With bond market participants selling, will stock market participants follow? And what will that mean for the global economy?