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U.S. Treasuries Shatter Historical Norms With 1% Yield in Reach

Liz Capo McCormick
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U.S. Treasuries Shatter Historical Norms With 1% Yield in Reach

(Bloomberg) -- Wall Street is now wondering just how low bond yields can go.

Historical norms, of course, suggest the chances of a 1% yield on 10-year Treasuries are still vanishingly slim. But to the likes of Bank of America’s Bruno Braizinha, it’s clear these aren’t normal times.

While Braizinha’s own statistical model pegs “fair value” for the benchmark U.S. note at closer to 2.5% based on current economic conditions, President Donald Trump’s trade war with China, the weakening global growth outlook and negative interest rates abroad will keep Treasuries in demand. That has the potential to push yields well below their all-time low of 1.318% if the “Japanification” of the $16 trillion Treasury market really sets in.

“The market is pricing in a significant deterioration of fundamentals,” said Braizinha, director of U.S. rates strategy. “That has us looking at a range of Fed easing scenarios,” with all likely outcomes pointing to even lower yields. The 10-year note ended at 1.65% on Monday.

The central bank lowered its benchmark rate at the end of July for the first time since 2008 and said it was ending its balance-sheet runoff early. The move came after Trump repeatedly harangued the Fed to ease its monetary policy to help boost growth.

The market is now locked into a “conventional” easing cycle, meaning traders expect the Fed to lower its target rate to zero by the end of 2020 or early 2021, Braizinha said. That means a 10-year yield of 1.2% to 1.5%.

As of Aug. 9, yields were already more than two standard deviations below “fair value,” based on Braizinha’s model, and are now approaching the extreme valuation levels last reached during the financial crisis.

If there’s an extended period of low growth and inflation marked by extremely easy monetary policy -- à la Japan -- parts of the U.S. Treasury curve could end up below zero. In a blog post last week, Joachim Fels, global economic adviser at fixed-income giant Pimco, raised this very possibility. With Europe and Japan inundated by sub-zero rates, Fels said it’s no longer “absurd” to think negative yields could come to the Treasury market, too.

“The scenario where the Fed cuts to zero, inflation goes nowhere and inflation expectations continue to collapse isn’t an impossible scenario,” Braizinha said.

To contact the reporter on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Michael Tsang, Nick Baker

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