Why are bond yields so low?
Source: Daily Telegraph
One of the most surprising market moves of 2014 was the persistent rally in US Treasury Bonds. It wasn’t supposed to be this way. Starting in April of 2013, rates were supposed to normalize. That’s when Ben Bernanke signaled that the Fed would gradually end its bond-buying program known as Quantitative Easing.
Yields quickly rose over 1%, and continued to drift higher, eventually topping out by the end of 2013 with the 10-year at almost 3%. This happened in other countries as well: yields rose and bond prices fell. Investors expected that higher rates in the US would lead to higher rates around the world.
But they didn’t move as much, elsewhere. Economies were decoupling. The Euro-zone, especially, wasn’t picking up steam. In fact, their economies were struggling to grow at all. So Euro interest rates started to fall.
A widening gap opened up between US Treasury bond yields and German Bund yields. And with the Fed expected to raise rates, the Dollar began to strengthen on foreign exchange markets. Faced with lower yields and a falling currency, many Euro-based investors began to buy Treasuries. So a stagnant European economy and persistent fears of deflation over there have pulled US interest rates lower, even as Federal Reserve officials talk about normalizing rates.
Where will all this go? What the currency markets giveth, the currency markets can taketh away. Markets are anticipatory. The Dollar has risen 15% over the last 6 months. If growth here falters or the ECB doesn’t begin its own round of QE or some new regulation is proposed, it could surprise a lot of investors. Currency markets live in their own special world.
What we’re seeing is a Dollar-based carry trade: sell Euros to invest in Dollars for the difference in rates. Some folks may get burned. If you live by the carry trade, you may just die by the carry trade.
Douglas R. Tengdin, CFA
Chief Investment Officer
Leave a comment if you have any questions—I read them all!