(Bloomberg Opinion) -- There’s something strange happening in the $17 trillion U.S. Treasuries market: Yields actually look compelling.
Not nominal yields, mind you. Yes, on Tuesday the yields on 10-year and 30-year Treasuries shot higher by 36 and 40 basis points, respectively, in the steepest one-day increases since 1982. But still, even after those moves, both maturities yield what would have been a record low just a month ago.
Rather, it’s so-called real yields, which amount to what holders expect to receive after factoring in inflation, that show a truly stunning move in the world’s biggest bond market. The U.S. 10-year real yield surged on Tuesday by more than 40 basis points, from just less than 0% to 0.39%, in the largest one-day move in Bloomberg data going back to 1997. It’s the highest since June, before the Federal Reserve cut interest rates for the first time this cycle. The 30-year real yield similarly lunged higher, jumping 41 basis points to 0.66%. Both maintained those levels on Wednesday.
Given the lack of liquidity plaguing the Treasury market, it’s hard to know for sure whether this huge move in real yields is, well, real. It stands to reason that the sharp increase Tuesday in nominal yields was because the Trump administration started detailing a fiscal stimulus package of up to $1.2 trillion to offset the economic damage of the coronavirus outbreak. In theory, that would brighten the outlook for economic growth.
To some, it rekindles concern about piling on to the U.S. national debt of $23.5 trillion. The outlook for the deficit looks “pretty scary,” Jeffrey Gundlach, DoubleLine Capital’s chief investment officer, said Tuesday in a webcast. There will be a lot of bonds for the market to absorb, he said, and “this is why I think interest rates are rising on the long end.” The Treasury yield curve is the steepest in more than two years, just about any way you measure it.
Usually, the fears of huge deficits lead to the conclusion that rampant inflation is inevitable. But that doesn’t appear to be on bond traders’ radars. Break-even rates, which serve as a market-based measure of inflation, have continued to plunge in recent days. Even after the fiscal stimulus proposals, they tumbled across the curve. At one point on Tuesday, traders saw U.S. inflation averaging just 0.62% over the next decade and 0.95% over 30 years.
Certainly, it’s possible that traders had underestimated the hit to global demand as more regions shut down economic activity to curb the spread of the coronavirus. On March 6, the 10-year real yield was -0.56%, the lowest since 2013.
Soon thereafter, Bloomberg News’s Anchalee Worrachate and Emily Barrett interviewed investors who weren’t fully convinced of the message sent by the Treasury market. Here was one such example:
“The bond market currently appears to be screaming a very different message than it did in 2008,” Jim Paulsen, chief strategist at Leuthold Weeden Capital Management LLC wrote in a note. “Both then and now there was and is panic. But in 2008, the bond market was dramatically raising the real bond yield on an economy in peril. Today, by contrast, the bond market is lowering the real yield, thereby aiding the economy.”
Based on Paulsen’s analysis, a deflation-risk message — like the one that presaged a recession in 2008 — occurs when inflation expectations fall faster than nominal bond yields, leading to a rise in real yields. This time, it’s the other way around. Since early November, the 10-year Treasury yield has declined by more than 100 basis points, while inflation expectations, as proxied by the breakeven rate, dropped about 70 basis points.
The upshot is a market repricing growth, not pricing in deflation.
This was March 11. Now, less than a week later, the market is moving in the opposite direction, wiping out months of declining real yields.
So, is the market now pricing in deflation? The most benign explanation might be that the U.S. is auctioning 10-year Treasury Inflation Protected Securities on Thursday, and their relative illiquidity is distorting prices ahead of the sale, especially given the continued decline in the price of oil, a critical component in the consumer price index.
But Fed Chair Jerome Powell did say at his press conference that “inflation will likely be held down this year.” Just how much it’s suppressed will go a long way toward determining whether these real yield levels are just a flash in the pan or something more permanent.
To contact the author of this story:
Brian Chappatta at [email protected]
To contact the editor responsible for this story:
Daniel Niemi at [email protected]
