Bonds were the story on Wednesday, as yields fell across the globe amid growth concerns triggered by renewed trade tensions, dour data and a trio of surprise rate cuts that seemingly validated market worries.
10-year yields in Germany fell to -0.60%, JGB yields pushed below the Bank of Japan’s ostensible “floor” and 30-year yields stateside are making a run at record lows.
The duration infatuation knows no bounds (especially not of the “zero lower” variety”).
Although 10-year yields in the US cheapened a bit after Wednesday’s auction, at 1.66%, we’re at levels that would have sounded patently ridiculous nine months ago.
The “Trump bump” – which conveyed reflation optimism – has vanished, and then some. As noted early Wednesday, the ~40bp drop in 10-year yields that’s unfolded over the past several sessions is the largest five-day decline since the debt ceiling debacle.
“Naturally” (or not, because negative-yielding debt is in many respects the financial embodiment of the word “unnatural”), the next question is how long it will before yields go negative in the US.
Although that’s an eventuality that’s been derided as unthinkable by some in the past, one person who says it’s time to consider it is Pimco’s Joachim Fels who wrote the following on Wednesday:
It is no longer absurd to think that the nominal yield on U.S. Treasury securities could go negative. Last week the German 30-year government bond yield dipped into negative territory for the first time ever. Around $14 trillion of outstanding bonds worldwide, or 25% of the market, now trade at negative yields, according to Bloomberg. What was once viewed as a short-term aberration — that creditors are paying debtors for taking their money — has already become commonplace in developed markets outside of the U.S. Whenever the world economy next goes into hibernation, U.S. Treasuries — which many investors view as the ultimate “safe haven” apart from gold — may be no exception to the negative yield phenomenon. And if trade tensions keep escalating, bond markets may move in that direction faster than many investors think.
In July, Fels warned that “the heyday of central bank independence now lies behind us”, and in the same Wednesday post, he argued that monetary policymakers “are not the villains but rather the victims of deeper fundamental drivers behind low and negative interest rates”.
He cites two familiar secular drivers: demographics and technology.
You can read more here, but the message is clear enough: Everyone is gradually coming around to Albert Edwards’s “Ice Age” thesis, although nobody is likely to couch their begrudging acceptance of the new reality in those terms.
In a February note, Edwards wrote the following:
I do not believe the Fed wants to rush to cut Fed Funds into negative territory, but the cost of not doing so will be very high if others are doing it (via a strong dollar). The Fed will be forced to participate as avoiding deflation will be the number 1 priority — not the profitability of the banking sector. Investors should contemplate a brave new world of negative Fed Funds, negative US 10y and 30y bond yields, 15% budget deficits and helicopter money. Sounds ridiculous doesn’t it? I hope I am wrong, but fear that I will be proved right.
10-year Treasury yields have fallen 100bps since Albert wrote those words.
On Wednesday morning, during the rates rally, one New York trader flagged a Eurodollar options trade targeting a negative fed funds rate in 2022.
I spent some time this morning thinking about how to do DCF valuations with negative risk free rates. Presumably something German and Japanese investors have figured out, but not something most US investors have ever conceived of.
H-Man, the line will be drawn if the 30 year TBond falls below the 1 month TBill rate which may happen sooner than we think.