Brexit Flips Script on Bond Market as Economic Signals Muddied

  • Ten-year yields touch lowest since 2012 despite growth signs
  • Treasuries gain for third week amid global debt rally

As opposing domestic and global forces vie for influence in the Treasuries market, the story of the U.S. economy may be getting lost in translation.

U.S. 10-year notes gained for a third week, with yields touching the lowest since 2012, as investors sought alternatives to more than $8 trillion in negative-yielding sovereign debt worldwide. Concern ahead of the U.K.’s June 23 vote on whether to remain in the European Union also boosted haven demand. U.S. yields declined even as U.S. growth estimates rose and data signaled an uptick in inflation.

Some investors read falling Treasury yields as a signal of U.S. economic weakness. Yet doing so confuses the relationship between economic fundamentals and market moves, economists at Deutsche Bank AG said this week. In fact, today’s ultra-low yields represent a departure from the traditional link between these forces, they said.

“I talk to so many clients who say, ‘rates are very low so you can see that the U.S. economy is unhealthy,’ and I immediately have to remind them that we are nowhere near a recession,” said Torsten Slok, chief international economist at Deutsche Bank in New York. “I tell them that 50 percent of Treasuries are held by foreigners, who look in their own backyard and see nothing but negative rates, so even U.S. yields at 1.60 percent look very attractive.”

Falling Yields

Bonds have staged a worldwide rally that pushed yields in Japan, Germany and Switzerland to record lows this week as central banks maintain or boost stimulus programs to combat flagging economic growth and inflation. The Federal Reserve on June 15 held rates steady and lowered its projections for the path of policy tightening, even as it left forecasts for U.S. economic growth and inflation little changed. Fed Chair Janet Yellen cited the risk posed by next week’s Brexit vote as one reason to stand pat.

Benchmark 10-year Treasury yields fell three basis points, or 0.03 percentage point, this week to 1.61 percent at 5 p.m. in New York Friday, data compiled by Bloomberg show, a third straight weekly decline. The price of the 1.625 percent security due in May 2026 was 100 5/32. The yield touched 1.52 percent on June 16, the lowest since August 2012.

‘Global Distortions’

“Ten-year yields have been offering more value compared to other sovereign bonds,” said Steve Kang, a U.S. rates strategist at Citigroup Inc. in New York. “The global factor has been the determinant factor for the 10-year yield for the past couple of months -- more so than the U.S. economic surprises.”

A measure of core inflation that excludes volatile food and fuel costs rose in May at a 2.2 percent annual rate, according to Labor Department data released June 16. The Fed targets a 2 percent inflation rate based on a separate gauge. The Atlanta Fed on Friday said its model for gross domestic product projected a 2.8 percent annualized growth rate in the second quarter, up from a 0.8 percent rate in the previous three months.

“The markets seem to be less sensitive to the economic data,” said Stephen Stanley, chief economist in New York at Amherst Pierpont Securities LLC. “The markets are so influenced at this point by some of the global distortions that the domestic data don’t have the influence they might have had in a more normal monetary policy environment.”

The latest drop in yields will test investor demand when the Treasury issues $88 billion of fixed-rate notes in three auctions next week. Elevated demand for U.S. securities left primary dealers, which are obligated to bid at debt sales, with record-low awards at a pair of note sales last month.

The Treasury cleared any bond sales from the day of the U.K.’s Brexit referendum in a move seen aimed at avoiding any impact from the vote. A $5 billion sale of 30-year inflation-protected securities was brought forward one day to June 22.

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