It’s no surprise that uncertainty around the impact of coronavirus (or Covid-19) has led to increased buying pressure in longer-maturity U.S. Treasuries, pushing yields lower, but the strength of the move has been unusual. While the run may not be over, and the economic backdrop in the short term has shifted, the size of the move is looking increasingly disconnected from economic fundamentals.
“The trend in Treasury yields has been firmly down since November 2018 despite a strong stock market,” said LPL Financial Senior Market Strategist Ryan Detrick, “but the most recent move is about more than attractive relative yields and the flight to safety.”
Virus-associated risk in Japan, including its economic relationship with China, is undermining the Japanese yen’s role as a safe-haven currency, supporting the dollar and in turn Treasuries. And since risk seems greatest in East Asia, followed by Europe, U.S. Treasuries have become even more attractive as a safe-haven asset for international investors. Buying also often leads to more buying as investors increasingly pile into a popular trade. As shown in the LPL Chart of the Day, the combined effect has pushed the 10-year Treasury yield below the 2016 all-time low.
It’s difficult to envision rates rising much in the short term. The move into longer-dated Treasuries seems crowded but sustainable for now. But increasing clarity around a rebound from the virus’ impact in the second half of the year, or even a Federal Reserve rate cut that helps restores confidence, could be a catalyst for a reversal. If we get any dollar weakness on top of that, the reversal could create some short-term pain. We continue to hold to our year-end forecast of 2–2.25% for the 10-year Treasury, with Covid-19 creating some downside risk to the forecast, and we would recommend a diversified mix of investment-grade bonds for appropriate investors.
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