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Why interest rates could go even lower

Talking Numbers

Why interest rates could go even lower

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Why interest rates could go even lower

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In an unforeseen twist to the markets, interest rates are at their lowest levels in over a year, leaving traders wondering if they will drop below major psychological levels.

The yield on the U.S. benchmark 10-year Treasury note closed August near 2.35 percent, and it may be headed lower. Some are even tossing around the idea of a return to 2.0 percent yields.

That’s a lot lower than where economists expected us to be when making their predictions at the beginning of the year. That was when the 10-year rate was around 3 percent.

A survey of 49 economists by the Wall Street Journal when 2014 started had average predictions of the 10-year yielding 3.24 percent by the end of June and 3.52 percent by December. A few had even higher estimates; Deutsche Bank’s Joe LaVorgna was expecting 3.5 percent and 4.0 percent for those respective time periods.

(Read: Treasurys rally takes a pause as ECB meeting looms)

Of course, that didn’t happen in June and the likeliness of seeing 3.5 percent within the next four months is pretty slim. Despite the Federal Reserve tapering its massive bond-buying program, other things happened this year, such as a flare-up between Ukraine and Russia.

And in the Europe Union, a weak economy and very low inflation has brought their yields to astonishingly low levels. Yields for Spain’s 10-year government bonds are actually even lower than that of the United States while Germany’s 2-year note yields are at negative rates, meaning investors are paying to lend Germany money.

What’s going on in Europe has had an effect on U.S. rates, said Ira Jersey, director of U.S. interest rates strategy at Credit Suisse.

“Longer term Treasurys, like the 10-year, have been highly influenced by European yields continuing to fall to record lows,” Jersey said. “Low global interest rates have made the U.S. Treasury market the highest yielding of the major government bond markets along with the U.K.”

Thus, is it possible for U.S. 10-year Treasury notes to hit 2 percent, if not lower?

“It’s possible but 2 percent is a psychological level for the markets,” said Gina Sanchez, founder of Chantico Global. “Even if we get close, it would be hard for us to break that 2 percent.”

(Watch: Why analysts say September could be a big deal)

But the technical case for getting down to 2.0 percent is hard to make, according to Jason Rotman, president of Lido Isle Advisors, but it could get fairly close. 

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“There is a hugely important trend line that started way back in the summer of 2012 on a major low in yields,” said Rotman, looking at a one-year chart of the 10-Year Treasury note. “And then the second low happened in 2013. If you draw a line connecting those two lows, you actually get an approximate target of 2.05, around that area. That’s theoretically, conceivably, that is a technical target.”

However, Rotman doesn’t think that’s likely because he believes the Fed will be concerned about inflation. Instead, Rotman is keeping an eye on the 2.33 percent level, which marks a 50 percent retracement of the rally in yields that happened last year.

“If the yields can break this very important level, my next major target – which I think would be the bottom – is a major consolidation level on the chart… about 2.2” percent, Rotman said.

To see the full discussion on what’s next for interest rates, with Sanchez on the fundamentals and Rotman on the technicals, watch the above video.

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