Three Things I Think I Think – Happy New Year! The highest supply in history directly implies the lowest prices in history, for every market in the world — except U.S. Treasuries.”. To the extent that the rich have higher propensities to save, more money flows into capital markets to fund investment. Interest rates around the world, both short-term and long-term, are exceptionally low these days. Bond traders aren’t an overly complex group of people. In today's "Off the Charts," Bloomberg's Scarlet Fu takes a look at why U.S. Treasury yields are so low. From a bond traders perspective that means one thing – yields aren’t going to surge because the economy will remain weak and even if the economy strengthens marginally the Fed has been very clear that they’re going to play it on the safe side and keep rates low for several more years. Thirty-year Treasury yields were also off their record low of 0.70%, last trading at 0.904%. Though the 10-year Treasury note yield booked its largest weekly rise since June at the end of last Friday, leaving it at 1.13% at last check, the real 10-year yield stood at negative 0.93%. Again, reduced demand for capital puts downward pressure on interest rates. There are, however, also upsides to the decline in interest rates. Old technologies, such as railroads and auto factories, required large capital investments. When the Fed sets low rates, it is acting more like a messenger, telling us that the economy needs them to maintain equilibrium. For example, as treasury yields increase, so do other interest rates. Of course, the Fed’s not doing that, but this doesn’t mean their communications are not highly effective. It meant that investors did not require a higher yield for longer-term notes. After all, the Fed sets interest rates, doesn’t it? I often use the analogy of a dog on a leash. So bond prices are rising and yields are falling. Some economists have suggested that with interest rates so low, the government need not worry much about increases in government debt. In January 2006, the yield curve started to flatten. Economists don’t entirely know why rates have been so low for so long, or whether they will turn out to be mainly a boon or a danger. Since the 1970s, average economic growth has slowed, perhaps because of a slower technological advance. In the evolution of the U.S. economy over the past four decades, one fact stands out as especially puzzling: the large and fairly steady decline in interest rates. As the economist Irving Fisher noted almost a century ago, when bond investors expect high inflation, they anticipate that repayment will be made in significantly less valuable dollars, and they demand a higher interest rate to compensate. His view is a conspiratorial one of the Treasury market that was then followed up by a series of different responses from Joe Weisenthal, John Carney and many others. Consider what has happened to three key benchmarks. Reduced demand for capital lowers interest rates. Treasury yields can indicate the overall state of the stock market and the general economy. Which of these hypotheses is right? The question is an active area of research. So demand is high thanks to this dynamic at work. So, I don’t think we need conspiracies or asset shortages to understand what’s going on here. Since rates and … My guess is that a more plausible projection is an inflation-adjusted return of about 3 percent. For example, if they reflect low growth expectations, then counting on strong growth to reduce the debt-to-G.D.P. We don’t yet know which edge will be sharper. We just need to understand the thinking of a very influential entity forecasting a very clear message to the market that says: “buy our bonds, we’ll make sure you don’t get your face smashed in any time soon!”, "While Ben Graham was the consummate 'bottom up' investor, it could be said that Cullen Roche is the consummate 'top down' investor." In September 1981, the 10-year Treasury note yielded over 15 percent. As I’ve previously noted, there’s a very high correlation between moves across the curve and the Fed’s actions. Although government debt is near its highest point as a percentage of gross domestic product, servicing it hasn’t been a problem. Some thoughts: It also means that individuals will need to rethink retirement saving. Inflation and the Constantly Low Yield Environment Bond yields are based on expectations of inflation, economic growth, default probabilities, and duration. It’s a fair question a number of investors are asking themselves as we stare at generationally low yields in safe assets. Since Treasury yields are largely below 1%, they’re not going to be a great income generator, he said. Why Treasury Yields Matter. Traditionally, even bonds from countries with a low chance of default contained some amount of risk because there was a risk of inflation or that bond prices would change. Experts have long looked at the 10-year U.S. Treasury yield … The natural rate is determined not by the central bank but by deeper market forces that govern people’s supply of savings and businesses’ demand for capital. Over the same period, the critical short-term rate set by the Federal Reserve, the federal funds rate, has fallen to nearly zero from about 16 percent, and the rate on 30-year mortgages has dropped below 3 percent from over 18 percent. As of today, 1y Treasury yields are 0.11%, 3y are 0.21%, 10y are 0.88%. This, in itself, is an absolute financial contradiction. N. Gregory Mankiw is the Robert M. Beren professor of economics at Harvard. But broader, long-term factors like slow economic growth, tepid inflation expectations and not enough safe assets to go around have all contributed to the yield decline this year, analysts said. In the end, low interest rates are a double-edged sword. The Chinese economy has grown rapidly in recent years, and China has a high saving rate. First, falling bond yields are driven by the macroeconomy, and are nothing new. But this so-called Fisher effect is only a piece of the puzzle. As U.S. Treasuries hit historic lows, real yields have gone below zero. But interest rates could always return to more normal levels. Events like the financial crisis of 2008 and the current pandemic are vivid reminders of how uncertain life is and may have increased people’s aversion to risk. There’s been a bit of a controversy brewing in recent days over the treasury market and why yields are so low. Is All of Finance Just a Big Network Effect? That is, the Fed controls 100% of the curve at the short-end and the market controls an increasing portion of the curve the further out we go. This Man Lost Everything Betting on Stocks, see my debunking of the “bond bubble” from several years f, EVENT ANALYSIS: Thoughts on the Eurozone “Breakthrough”. Hypothetical scenarios using the yield on a 3-month Treasury bill of 0.1% and the yield-to-worst of an average 5-year corporate bond of 1.0%. Feb. 2 -- In today's "Off the Charts," Bloomberg's Scarlet Fu takes a look at why U.S. Treasury yields are so low. The federal funds rate is back near zero, the 10-year Treasury yield remains stuck in a 0.5%-to-0.75% range, and inflation-adjusted (real) yields are deep in negative territory. It all started earlier this week when Jeff Nielsen of Silver Gold Bull wrote: “Previously, my own writing has focused upon one particular aspect of this absurdity: the highest prices for U.S. Treasuries at a time of maximum supply. It all started earlier this week when Jeff That is probably right, to a degree. As this vast pool of savings flows into capital markets, interest rates around the world fall. But as we go further and further out the market controls more of the movement, but that doesn’t mean the Fed has no control of the long-end  and in fact, if they wanted to, the Fed could theoretically control the entire curve. Ie, Ben Bernanke writes a love letter to the bond market saying: “Dear Bond Traders, we will be buying an unlimited amount of 30 year bonds at X%, and since we have unlimited ammunition to perform this task we hope you enjoy getting your faces smashed into the concrete if you should be so foolish as to take the other side of this bet. One reason for the interest rate decline is a drop in inflation expectations. At the same time, M2 money supply grew from 15.5kB on Mar 2nd to … The traders can run the leash out ahead of the owner and from side to side, but they don’t want to get too far away or they risk getting choked. Some answers are clear, but many more are elusive. According the University of Michigan’s survey of consumers, expected inflation fell 4.3 percentage points from September 1981 to September 2020, explaining only about a third of the decline in interest rates. Economists don’t entirely know why rates have been so low for so long, or whether they will turn out to be mainly a boon or a danger. This debate has been going on for years in some form or another (see my debunking of the “bond bubble” from several years for related thinking) so I’ll keep my opinion on this short and sweet since I think the current environment is a rather simple one to explain. Stimulus check update: $600 checks will hit some bank accounts Tuesday night, says the Treasury. Treasury Yields Predicted the 2008 Financial Crisis . On Jan. 3, … Another factor related to the yield is the time to maturity. The rate on the benchmark 30-year Treasury bond sank to an all-time low on Wednesday while the U.S. yield curve inverted even further as fixed-income traders grew more confident in … So, in a world of messy assets where foreign bonds look unattractive, real estate is in the dumper and equities appear exceedingly risky, this communication from the Fed makes the Treasury market appear like a relatively safe short-term place to invest. She speaks on "Bottom Line." Some of the implications of low interest rates are already clear. Their increased precautionary saving and especially their greater demand for safe assets drive down interest rates. ratio, as the United States did after World War II, might not be an option. Why Treasury yields are so low given such an increase in M2? That means that institutions like universities that use the return on their endowments to fund their activities will need to tighten their belts. They don’t like to lose money because they get fired when they lose money. She speaks on "Bottom Line." Key points: Treasury yields currently offer investors virtually no real return above inflation. But the more important dynamic here is the source of this demand. For example, a balanced portfolio of half stocks and half bonds has historically earned a return of 8.2 percent, or about 5 percent after inflation. Japan's giant pension fund wants to know why low interest rates are so stubborn. There’s been a bit of a controversy brewing in recent days over the treasury market and why yields are so low. Some economists, most notably the New York University professor Thomas Philippon, have suggested that the economy is less competitive than it once was. If so, servicing the debt would become more costly. The third scenario assumes the Fed funds rate is increased to 1% in year three, resulting in 3-month Treasury bill yield … Even without recent fears about the coronavirus and an oil price war between Saudi Arabia and Russia, Treasury yields have been low after years of easy monetary policy from the Federal … Finance. Treasury notes are market traded and in 2020, … Several hypotheses might explain the decline in the natural rate of interest: As income inequality has risen over the past few decades, resources have shifted from poorer households to richer ones. When expected inflation falls, as it has over the past 40 years, interest rates typically do as well. So keeping a close tab on Fed communiques is important in the bond market. Why Investors Fell for Low-Yield Savings in 2020 ... the federal government while also providing a greater yield than some savings accounts. – David Foulke, Alpha Architect. In the short run, yes, but not in the long run. In many cases, yields … Meanwhile, yields on riskier fixed income investments… For much the same reason, public and private pension plans are probably more underfunded than current estimates suggest. Long-term bond yields in major advanced economies have fallen noticeably over the past six months. We can get into complex discussions about “safe assets” and “debt monetization”, but the simple fact of the matter is that demand for Treasury’s has been extremely high regardless of the supply. (Source: Bloomberg) Today, it yields less than 1 percent. Statement on Monetary Policy – May 2019 Box B: Why Are Long-term Bond Yields So Low?. Interest rates have fallen rapidly, to the point where many in the market believe the benchmark 10-year Treasury yield, which impacts mortgage rates, could fall below 2%. The Fed aims to set interest rates at levels that will produce full employment and stable prices. Businesses with increasing market power not only raise their prices but also invest less. “But holding Treasuries, the ultimate safe-haven investment, is a great diversifier of … Source: Bloomberg and the Schwab Center for Financial Research. Moreover, some of the causes of low interest rates might give reason for concern. These rates include mortgage interest rates, auto loans, and business loans. The remaining question is why inflation-adjusted interest rates — what economists call real interest rates — have declined so substantially. What accounts for this decline, and what does it imply for personal and public decision-making? Why Are Bond Yields So Low? The Treasury market is really just an extension of Fed communications, which are an extension of economic strength/weakness. So why would you even own bonds with rates this low? Very likely, a combination of these forces is at work. They’d just do the same thing at the 30 year bond that they do with the overnight market and they’d set the price verbally. It may be tempting to blame the Fed and specifically its recent chairs, Jerome H. Powell and Janet L. Yellen, whom President-elect Joseph R. Biden Jr. has nominated to become Treasury secretary. ... the 30-year Treasury bond yielded a parsimonious 3.02%, the 10-year, 2.41%, and the five-year only 1.90%. America’s aging population is limiting the nation’s growth potential, but that is only a partial explanation for the decline in long-term yields. New technologies, like those developed in Silicon Valley, may be less capital-intensive. Bond investors face a challenging environment. This level is sometimes called the natural rate of interest. An unprecedented asset buildup among central banks … Wider economic factors. Thanks for playing, Ben.”. From a bond traders perspective that means one thing – yields aren’t going to surge because the economy will remain weak and even if the economy strengthens marginally the Fed has been very clear that they’re going to play it on the safe side and keep rates low for several more years. According to my calculations, to support any given level of spending for a 20-year retirement, a person’s nest egg entering retirement needs to be 19 percent larger. Bond traders are a lot like a dog on a 30 foot leash. And at the base the Fed controls 100% of the movement. Young families looking to buy homes, for example, benefit from the lower cost of mortgage financing. A decline in growth reduces the demand for new capital investment, pushing down interest rates. So when the Fed repeats, on a monthly basis, that yields will be “exceptionally low through at least 2014” then the message is clear – “we think the economy is exceptionally weak and we expect to keep rates low for several years”. 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