Yielding to Panic

A photo representing the signing of the original brokers agreement, founding the New York Stock Exchange, May 17, 1792. Photograph by AP Photo

Marinate your mind in this for a minute: Long-term U.S. Treasury yields are essentially at a 220-year low, says Barry Ritholtz. Mind you, 1792 was when two dozen brokers met under a buttonwood tree in Lower Manhattan to shake hands on what would ultimately become the New York Stock Exchange. And when George Washington, while test-driving his second set of experimental dentures, cast the nation’s first presidential veto. And France first successfully used its guillotine. Those 220 years traversed at least three panics, two depressions, two world wars, multiple global economic crises, a Great Recession, and “Who Shot J.R.?”

All that history be damned; on Thursday the 10-year Treasury touched a record-low yield of 1.5309 percent. Thirty-year bonds, for their part, fell to a yield of 2.6 percent, which is just above the all-time low they set in the midst of the Panic of 2008. Apparently our times are so fraught with fear and the need to flee to safety that the Treasury market is pricing in historic amounts of misery. As the Wall Street Journal’s Dennis Berman tweeted, “Even in ancient Babylon (4%), Medieval Europe (6%), 1800s America (4%), no one was paying 1.6% for 10-year money.”

Why would anyone loan money to Uncle Sam for so long at so little? After all, it’s not like our fiscal prospects are such great shakes. Surely there must be a price to pay for epic amounts of monetary stimulus—three-plus years of zero-interest-rate policy, two rounds of quantitative easing—and Washington’s inability to balance its books. But the consensus is apparently that we’re less doomed than our cousins across the pond, so much so that the hunger for U.S. debt becomes increasingly rapacious with every new turn of the global financial crisis. “If you look at the global marketplace, we are the supermarket of safety,” says William Larkin, a bond manager at Cabot Money Management. “We’re talking about an elevated level of fear. This is mainly driven by growing uncertainty in Europe. People are saying ‘I can buy the Treasury, and I know my money will be returned to me.’”

By comparison, the Standard & Poor’s 500-stock index offers a 2.18 percent dividend yield. But so what? Outflows from U.S. equity funds are all the rage—especially to fund more purchases of bond funds. Writes Randall Forsyth in Barron’s: “This mindset is sending investors fleeing from risk assets, which by most valuation metrics are relatively cheap, and toward safe-haven government bonds that, by any conventional scale, offer no investment value whatsoever at the lowest yields in history and unprecedented outside of Japan.”

To call Treasuries a crowded trade is to flog the too-obvious. Indeed, yields that seemed impossibly low just months ago manage to keep falling ever lower. Still, you can’t help but wonder if long-term bond investors who accept essentially negative yields after inflation and taxes really understand what they are getting into. And how difficult it could be to get out of.

Consider that in 2007, before the onset of the financial crisis, 10-year Treasury yields were at 5.3 percent; they’ve averaged just less than 5 percent for the past two decades. Investing in the 10-year at today’s record low would entail a 19 percent loss if yields shot up to 5 percent by 2014.

And they call this the risk-free rate.

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