The current respite in the relentless drop in yields that’s gripped the $16 trillion Treasury market isn’t likely to last for very long.
All of the ingredients needed to keep the bond rally going, and thus push yields even lower, are already in place: U.S.-China trade tensions, weak global growth, concerns about Brexit and maybe a spice of Argentina or Hong Kong turmoil. None of them are likely to be fully resolved in the next few weeks or months, and even the possibility of the U.S. issuing 50- to 100-year bonds feels like just a temporary salve, said Tony Farren of Academy Securities Inc.
“We need to have reasons for Treasuries to sell-off in order to keep a lower-yield scenario from unfolding,” Farren said in a phone interview. The Norwalk, Connecticut-based managing director sees a possibility of the five-year Treasury yield hitting 1%, the 10-year breaking through its record low of 1.32%, and the 30-year falling to 1.70%-1.75%, all by mid-October.
The once-unthinkable scenario of collapsing U.S. yields may also keep unfolding in an altogether different fashion. While last week’s bond-market rally was fueled by panic, Wednesday’s drop in yields may have been driven by technical factors. What comes next may be based on little to no new information in the markets, observers said.
“Phase one was people running around with their hair on fire,” Memphis-based FTN strategist Jim Vogel said in a phone interview. “Phase two was supposed to be yields recovering, but instead it’s been the opposite. Phase three is when the curve and yields begin to snowball, with nothing knocking them off course.”
Unlike the 30-year yield which fell to a record low of 1.90% on Wednesday and the benchmark 10-year rate that broke below 1.5% this week, their five-year cousin has been relatively more immune from the price action, at 1.41% as of Thursday, and is still some distance away from its lowest level of 0.53%, according to Vogel.
But that could start changing by next week. He says the five-year rate could drift lower, to 1.32%, even before August U.S. payrolls are released on Sept. 6 “just to relief pressure on the curve.” “Losing that five to 10 basis points without any external catalyst driving is going to be painful,” Vogel said, adding the 5-year “is possibly the next leg lower in yields that people are not anticipating.”
Just about the only thing that could dramatically alter the equation is a resolution to U.S.-China trade tensions, according to Farren. “Treasuries would sell off if a good deal is announced and that would drive market pricing for the next few weeks and few months,” he said. “But how many times have we had the tea leaf put in our face — that U.S. and China are making significant progress — only to have it yanked away?”