US Treasury yields are creeping up once again — despite the Fed’s best attempts to flatten them via quantitative easing.
And, as this chart from Deutsche Bank shows, they’re not just creeping up, they’re re-coupling with stocks — something not seen since December, when the Fed began its QE. Before that, bonds and equities were strongly correlated, with yields falling in tandem with stock prices at the height of the financial crisis.
Low yields are important to US financial recovery efforts — not only do they help fund the raft of measures being implemented, they help stimulate the economy, appearing in tandem with lower mortgage rates and thereby aiding the refinancing programme. A bond sell-off (higher yields) would effectively throw a spanner into that refinancing programme — not something the government would welcome right now, economic green shoots or no.
Here’s Deutsche Bank’s Mustafa Chowdhry and Marcus Huie on the issue:… in the last week, the Fed’s influence seems to have waned, as some of the former correlations seem to have reasserted themselves. The rising equity market has brought higher yield levels and higher TIPS breakeven rates. The recent rise in yield levels has come about for several reasons. First, the economic data has showed that the economic decline has been decelerating. In particular, the rise in consumer confidence, and the small fall in house prices with the Case Shiller report, indicated that the economic environment was no longer in free-fall. Second, there was some mitigation of the anxiety about banks with the improvement in Q1 bank earnings. Finally, we are in the middle of two consecutive weeks of heavy Treasury supply, with the 2Y, 5Y, and 7Y in the past week, and the quarterly refunding of 3Y, 10Y, and 30Y in the coming week. Not only have yields risen, but the curve has steepened, particularly in the 2/5Y, with the 2Y being supported by excessive crowding into the carry trade. This has carried into a strong rally in the 2Y TIPS real yield. 5Y breakevens rallied as well, with nominal 5Y underperforming substantially.
Our view on the future direction of Treasury yields will depend on two things: Whether the flow of economic data will be more positive than expected, and whether the Fed will intervene through balance sheet activity in sufficient scale to cause a break in the correlation relationship again.
On the economic recovery front, there’s been much optimism of late. However, Pimco’s Bill Gross, who may as well be a proxy for US government thinking on bonds, is still advising investors to “shake hands with the government”. Here’s an extract from his latest investment outlook.
Do not be deceived by the euphoric sightings of “green shoots” and the claims for new bull markets in a multitude of asset classes. Stable and secure income is still the order of the day. Shaking hands with the new government is still the prescribed strategy, although it should be done at a senior level of the balance sheet. If the government indeed becomes your investment partner, you should keep the big Uncle in clear sight and without back turned. Risk will not likely be rewarded until the global economy stabilizes and the Obama rules of order are more clearly defined.
Related links:
The return of the yield? – FT Alphaville
US Treasuries, not treasured by Fed, or Gross – FT Alphaville