Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

Wall Street analysts are still warning that benchmark borrowing costs will rise. Traders have learned to wholeheartedly ignore them and probably rightly so.

These strategists have been wrong for years, and especially so in 2016. Not only have rates on U.S. Treasuries dropped, not risen, they’re sinking to record lows without a clear sign of a bottom. The government debt has gained 5.9 percent so far this year, its best return for a similar period since 1995, according to Bank of America Merrill Lynch index data. The volume of bonds with negative yields has surged beyond $12 trillion.

And yet here comes Goldman Sachs, sounding an alarm yet again about how U.S. yields are poised to increase and that investors are overreacting to Britain's vote to leave the European Union.

"The U.K. is not a global economic bellwether, and hence any economic activity slowdown should have a limited impact," Rohan Khanna, a London-based interest rates strategist at Goldman, wrote in a note cited by Bloomberg News reporter Kevin Buckland on Tuesday.

Goldman is not a complete outlier when it comes to believing Treasury yields will rise soon. Bank analysts surveyed by Bloomberg still predict that U.S. benchmark borrowing costs will generally increase this year.

Bold Predictions
Analysts believe 30-year Treasury yields will rise this year, even as they fall to record lows
Source: Bloomberg

The Goldman analysts are correct that the so-called Brexit vote isn't, in itself, catastrophic for the global economy. But that's not the only dynamic driving down yields or arguably even the main one.

Rather than explain all the reasons that Treasury yields will probably stay low or even decline further, let’s take a look at what would have to happen for benchmark rates to rise in any sort of meaningful way:

1) The historical relationship between U.S. and other developed-market rates would have to break down. Ten-year yields in Japan and Germany have fallen below zero. Relative to those rates, U.S. yields still look historically high.

Relative Value
U.S. Treasuries still yield quite a bit relative to other developed-market sovereign bonds
Source: Bloomberg

2) The U.K.'s vote to leave the EU would have to be either overturned or mitigated by favorable new trade arrangements and pro-business incentives. It would also have to be a single event rather than a signal of escalating political risk rippling through the world.

That's hard to believe considering what's going on in places like Italy, which faces a banking crisis and is holding a referendum later this year on overhauling its political system, and the U.S., given the increasingly contentious presidential race.

3) Central banks from Japan to Britain to Sweden and the U.S. would all have to prod rates upward, or at least stop dropping them. Right now, they seem headed in the opposite direction, with the Brexit vote most likely delaying rate increases in Sweden and the U.S. and European central bankers considering adding additional stimulus measures.

4) There would have to be some signs of inflation. There aren't any, at least to any significant degree. The U.K. economy may contract. Oil prices are likely to plateau or even dip again in the near future. Derivatives traders are now predicting a 1.49 percent longer-term inflation rate, close to the lowest since 2009.

Slow Slog
Derivatives traders have been lowering their implied expectations for long-term inflation rates
Source: Bloomberg

Wall Street analysts are taking an increasingly contrarian view given a backdrop of political uncertainty, unprecedented stimulus efforts and moribund growth. And in fairness, it's easy to dislike yields at such low levels.

Record-low rates are crimping the balance sheets of banks and institutional investors. It doesn't make sense from any sort of historical investing logic that companies are being paid to borrow money in Europe and Japan. But wishful thinking is no match for market forces. The momentum is still moving toward lower rates, and it's hard to see what'll stop it just yet.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net