US yields at all-time low

The coronavirus-induced rally in government bond prices has pushed yields on US Treasury securities to all-time lows. The downward trend is now more than overdone from a technical analysis standpoint. A (temporary) low point has now probably already been hit. In the latest crisis, US government debt securities have once again proven to be a safe haven and a good hedge for investor portfolios. This hedge insurance protection, though, may lose effectiveness in the next crisis.

 

All-time lows close to the zero line

Three weeks ago, 10-year US Treasury notes were yielding 1.5%, a level that had previously marked an upward inflection point in the summers of 2012 and 2016 as well as last autumn. But this key technical support level didn’t withstand a recent fourth test because the plunge on the equity markets caused by the coronavirus epidemic prompted investors to reflexively flee to safe-haven assets, an oft-observed behavior pattern. Those safe havens include gold (and Swiss real estate) and, just as much as ever, government debt securities issued by the USA, the world’s most liquid bond market. While stocks saw veritable panic selling at the start of this week, US Treasurys saw full-blown panic buying. The buying frenzy was driven not just by coronavirus fears, but also by an emergency interest-rate cut by the US Federal Reserve and a rapid reassessment of the outlook for US policy rates – the financial market now expects to see another 100 basis points of rate cutting very soon.

 

Oversold like seldom before
Realistic chance for a yield floor

10-year US Treasury yield and relative strength index (RSI)


The Fed’s rate cutting and the market’s expectations for more to come left a near-exponential spike in bond prices and, inversely, a drop in yields almost to rock bottom on the charts. On Monday, for instance, the yield on 10-year US Treasury notes intermittently stood at just 34 basis points while 30-year Treasury bonds yielded just 71 basis points. Given their high duration, 30-year Treasurys over the span of just two trading sessions (March 6 and 9) registered an all-time record gain of 15.8%, an impressive performance indeed, but which at the same time is a telling sign of speculative excess.

 

Uptrend overdone?
Every crisis has its flagpole

Futures contract on 30-year US Treasury bond

Not just technically overdone

Because when we take a look at the 30-year US Treasury bond’s long-term price chart, the crisis-induced flagpole isn’t the only thing that’s conspicuous. It also becomes evident that the rally that kicked off this week lifted the 30-year Treasury price to the upper edge of the long-term uptrend channel. The 30-year Treasury yield, conversely, has rarely been as oversold as it is at present, according to momentum indicators such as the relative strength index. Against this backdrop, from a technical analysis perspective, the spike in bond prices and the selloff in yields appear extremely exaggerated. But this isn’t all that portends a U-turn (which has already happened) and the formation of a floor at a low level. What’s also clear is that the latest market movements have pushed US yields down close to the “ultimate floor” because if the Fed doesn’t lower its policy rate into negative territory, the zero bound is likely to mark the lower limit for US yields not just for short-term maturities, but also for medium- and long-dated tenors.

In the midst of the current crisis, US Treasury bonds have once again proven their status as an insurance policy for investor portfolios.

 

We see a high probability that the USA’s central bankers will not follow their European and Japanese colleagues on the road to negative policy rates. Various Fed spokesmen in the past have repeatedly spoken out against doing that. A cut in the federal funds rate to 0%–0.25% in the days and weeks ahead is practically a foregone conclusion in light of what the financial markets are currently clamoring for from the Fed. Beyond that, though, the Fed otherwise looks set to exercise creativity in its monetary policy, pulling a Japan-style yield curve management setup out of its toolbox, for example, in addition to issuing familiar forward guidance and buying up more securities.

 

Zero interest rate inevitable
The markets expect to see more big rate cuts

2-year US Treasury yield and US federal funds rate

Expensive insurance (with only limited capital protection)

In the midst of the current crisis, US Treasury bonds have once again proven their status as an insurance policy for investor portfolios. Despite severe drawdowns on the equity markets, actively managed mixed mandates have dipped only mildly into negative territory year-to-date. However, it’s questionable whether US Treasurys will be able to fulfill their function as a portfolio hedge equally as well in the next crisis. Weak economic growth, tame inflation and central-bank monetary policy accommodation should keep bond yields at a relatively low level despite the floor that we expect to see form. The drop height for yields to the presumed lower bound (the 0% line) thus looks destined to be smaller during the next recession, which means that the potential for price gains on bonds correspondingly will also be smaller. In such a scenario, only extremely long-dated bonds would offer better portfolio protection, but taking on even greater interest-rate risk would be the price one would have to pay for that protection.

Against this backdrop, the dearth of decent investment opportunities for putting the more stable elements of a diversified portfolio in place will worsen further in the years ahead. Gold and real estate funds remain two of the few options left among the traditional asset classes. Both benefit from a climate of sustained ultralow market interest rates, and a weak US dollar gives the yellow precious metal additional support. Active portfolio management and securities picking will likewise gain importance. In order to keep achieving a good risk-adjusted performance in the future, the focus is likely to shift more toward solutions such as alternative investment products.

The current coronavirus shock and the resulting selloff in bond yields are like a coin with two sides for stocks. The rampant uncertainty and the muting effect on economic growth and corporate earnings are hurting the equities asset class in the near term. But when the coronavirus smoke clears a few weeks or months from now, it will leave behind an environment of ultralow market interest rates, vigorous monetary policy accommodation and fiscal stimuli that should give stocks a powerful tailwind. Since the attractiveness of equities relative to fixed-income assets will further increase, stocks remain practically indispensable for those investors with a medium- to long-term investment horizon.

Oliver Hackel, CFA Macro and Investment Strategy, Behavioral Finance and Technical Analysis

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