The bond market sold off sharply this week, but don’t get too comfortable. After all, we’ve been here before and, unfortunately, it never lasts.
It seems every time Euroquake recedes from the headlines, the Treasury market loses its bid. And just when investors start to get complacent, a new tremor sets them running in panic for the safety of U.S. government debt.
The yield on the benchmark 10-year Treasury note has been climbing steadily ever since European Central Bank President Mario Draghi issued some tough talk at the end of July, saying he was committed to do whatever it takes to save the euro. (No action, mind you, just words. But that, at the time, was enough.)
The yield on the 10-year started drifting up from all-time lows of about 1.4% around July 23, a couple days before Draghi spoke, then went pretty much vertical this past week — shooting to 1.8% from 1.65% over the span of five sessions.
But just because the flight from risk has cooled off recently doesn’t mean all’s suddenly well in the world.
For one thing, a yield of 1.8% still says something seriously scary about the bond market’s expectations for future growth — and investors’ faith in stocks.
Heck, rates have been down so long, this actually looks like up to us? Just have a look at this five-year chart of 10-year Treasury yields, courtesy of S&P Capital IQ. From 4.6% in August 2007 to 1.8% today — all when we’re supposedly in the third year of recovery:
So the yield on the 10-year is now at a three-month high? Big deal. It hasn’t maintained a level above 2% — 2%! — for more than a year. It hit 2.1% during the depths of the financial crisis and was as high as 3.65% in early 2011. In 2006, about the time the housing market started to roll over, the 10-year was yielding more than 5%.
As the chart demonstrates, we’ve seen yields back up repeatedly in very big moves, and none of them have stuck. From left to right, this chart goes down, down, down. Going back to 2008 — a year in which the 10-year note yield sank from 4.04% to 2.25% — “there were exactly EIGHT periods of yield hiccups of at least 30 basis points (the average being 40 bps),” wrote David Rosenberg, chief economist and strategist at Gluskin Sheff, when we had the last big sell-off in March. (A basis point equals 0.01%.)
And none of those sell-offs lasted.
True, there are ample reasons for traders to bail on Treasury prices these days. U.S. economic data has been firming lately, leading to upward revisions to third- and fourth-quarter GDP. Second-quarter earnings were less bad than feared, even if outlooks are dismal. German and French GDP came in better than expected, too, and European policymakers are saying all the right things to maintain confidence in the euro. (The market has so far been giving them a pass on the lack of an actual action plan.)
That has helped prop up risk assets at the expense of bonds, but if past is prologue, it won’t last. It’s too quiet out there for one thing. The VIX (CBOE:VIX) volatility index, also known as the investor fear gauge, is plumbing the depths. And an ultra-low VIX is often a contrary indicator: When everyone is complacent, well, that’s when bad things can happen.
Finally, just like stocks, the bond market never moves in a straight line. The record-setting run-up we saw into late July was bound to reverse. Bond traders take profits and look for better entry points, too, you know.
I’m not rooting for low yields — I just don’t think we’ve seen the end of the secular bull market in government debt. Not when the global economy and financial system remain fragile, and the risk-off trade can come roaring back on a single headline.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.