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Forget the economy – this is why rates are so low

Lawrence Lewitinn
Talking Numbers

Interest rates and volatility are taking the plunge.

In the past month, the 10-year U.S. Treasury yield and the CBOE Volatility Index (known as the VIX) have been moving in the same direction. That direction, of course, is down. As the 10-year yield touches the 2.4 percent level –its lowest in nearly a year – the VIX is hovering around 11.5 percent, near its lowest levels since before the financial crisis.

That's somewhat odd, since a lower VIX means investors don't need to flee to the safety of bonds. That, in turn, would mean higher bond yields. But, instead, investors are bidding up bonds during a period of low volatility and rates are thus going down.

Portfolio manager Chad Morganlander of Stifel's Washington Crossing Advisors thinks the drop in U.S. Treasury yields has less to do with the sort of economic anxiety that would spike the VIX, and more to do with prices of foreign government bonds.

(Read: Benchmark Treasury yields edge up from 11-month lows)

"I don't think the long end of the yield curve is moving down because the global economy is falling out of bed," Morganlander said. "It's more of a technical adjustment. Look at the Eurozone bonds. There's a disinflationary or deflationary trend occurring there, driving yields substantially lower."

As expected inflation goes down in Europe, nominal interest rates on European bonds fall, keeping their real rates in line. However, that means rates in some European countries are now close to that of the U.S., even though their credit risks may be higher. That makes 10-year yields more appealing than the other bonds available to fixed-income investors, according to Morganlander.

"You have French 10-year bonds trading well below the United States 10-Year," Morganlander said. "Give me a break! The credit risk, you're telling me, is better in France than in the United States?"


10-Yeargovernment yields

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Morganlander said lower first-quarter GDP may have played a factor in lowering rates, but so did fewer bond issuances by the U.S. Treasury, drying up some of the bond market liquidity.

Meanwhile, the technicals are also indicating lower bond yields ahead, according to Steven Pytlar, chief equity strategist at Prime Executions. He said the U.S. 10-year note generally doesn't trade very much on technicals. But that changed one year ago when then-chairman of the Federal Reserve Ben Bernanke first indicated the Fed would start to taper its bond-buying monetary stimulus program. The Fed ultimately began tapering in December.

Bond prices fell from May 2013 until the end of August of that year, leading to yields going up to just below 3 percent, from over 1.6 percent. Investors began buying bonds once again in the autumn when the Fed decided to put off the taper, kicking rates down to around 2.5 percent by late October. At that point, the markets anticipated that the Fed would taper in December, driving yields up to 3 percent once more. But once the taper was put in place, yields did something surprising – they began to drop.

"That tells us technically that investors had already priced in the taper," Pytlar said. "They had already priced in lower demand from the Fed for Treasury bonds."

(Watch: Frigid winter takes toll as US GDP contracts for first time in 3 years)

Pytlar agrees with Morganlander that macroeconomic factors are playing a role in keeping yields down. But, the appearance of a double top formation at the 3-percent yield level over the past year is a bearish for interest rates.

"Over the start of this year, we've seen a lower high in yields," Pytlar added. "Now we're moving below what could be called an important support level. So, there does look to be room technically for lower yields in 10-year bonds."

To see the full discussion on the U.S. Treasury 10-year Note, with Morganlander on the fundamentals and Pytlar on the technicals, watch the above video.