We examine a few of the possible explanations for the recent precipitous drop in US Treasury yields.
In Thursday’s trading, the US Treasury 10YR Yield Index TNX reached 1.275% on its default chart after closing at around 1.48% last Thursday – a drop of around 20 basis points in a week’s time. Throughout all of May and June, TNX traded within a 25 basis point range between 1.45% and 1.7% on its chart, which offers some perspective on the magnitude of this move.
A Bloomberg article from Tuesday, when TNX was around 1.35%, or 10 basis points higher than where it currently sits in its P&F chart, showed that its then-current level was three standard deviations below the level projected by JP Morgan’s “fair value model,” which is the largest deviation since fall of 2020. The model uses factors like inflation expectations, fed guidance, and recent economic data to predict an equilibrium level for the 10-year yield.
A number of explanations for the drop in yields have been offered including:
- A short-squeeze – when Treasury yields initially started to move down, against investors with who had taken short Treasury positions anticipating rising inflation and higher yields, they were forced to cover those positions, driving them down even further.
- Bond investors have lowered their expectations for economic growth and/or long-term inflation.
- Despite statements from FOMC members that tapering could begin in the fall, the market is predicting that the actual tapering will be slower than advertised.
- A flight to safety due to Increasing COVID-19 cases attributed to the delta variant, which has resulted in the resumption of lockdowns and social distancing measures in some countries, resulting in lower projections for the pace of global growth.
- Perceptions of how hot the Fed will let the economy (and inflation) run have shifted due to its recent more hawkish tone.
The reality is that are probably multiple factors driving the decline in yields. However, some of these explanations seem diametrically opposed – yields have declined because investors don’t believe the Fed will taper as fast as it has indicated vs. they’ve declined because of lower growth and inflation expectations due to the Fed’s more hawkish tone. The fact that we saw global equities decline Thursday in tandem with sovereign yields (in the US and elsewhere) runs counter to the idea that investors are doubting the Fed’s sincerity and believe the easy-money party will continue uninterrupted.
Whether due to tighter monetary policy or a resurgence of COVID-19, most of the other rationales that have been offered up have a common theme of investors adjusting their expectations for growth downward, which would be consistent with some of the other risk-off moves recently.
The sharp drop in Treasury yields merits our attention as it is a notable deviation from the norm and certainly has a risk-off undertone. That being said, at this point, there is no indication of weakness in the equities market. Even with Thursday’s decline the S&P 500 SPX and Nasdaq NASD both remain within 2% of their all-time highs, domestic equities remain atop the DALI asset class rankings, and US equity core percentile rank within the Asset Class Group Scores sits above 99%.
