(Bloomberg Opinion) -- You can almost feel the frustration starting to boil over in the world’s biggest bond market.
First, it was the risk of an unpredictable U.S. election that scared traders away from pushing for a breakout higher in U.S. Treasury yields. But once it became clear that Joe Biden would be the next president, and Pfizer Inc. unveiled a vaccine that was heralded as the most promising scientific advance in the fight against Covid-19, it seemed as if the benchmark 10-year yield was destined to reach 1% for the first time since March. After all, stocks were hitting records on economic optimism — surely Treasuries would sell off from this unshackled exuberance?
Not quite. The 10-year yield fell to as low as 0.816% last week, effectively erasing the market’s entire selloff since the first wave of positive vaccine news. So far this week, in the wake of even more positive vaccine results and battleground states certifying Biden’s victory, yields have merely inched higher, to about 0.88%, while the curve from five to 30 years has only started to pivot from the huge flattening that took hold for six of the seven trading sessions through Nov. 20. Overall, it’s not exactly a ringing endorsement of the path forward for the world’s largest economy.
The stock market, on the other hand, is indicating something quite different. The Dow Jones Industrial Average surged past 30,000 for the first time on Tuesday, with shares of companies devastated by the Covid-19 pandemic staging a huge rally that has the 124-year-old index on track for its best month since 1987. The purported reason: Investors expect vaccines and an orderly presidential transition will return the U.S. economy to something close to normal in the not-too-distant future. Boeing Co. jumped as much as 5%. JPMorgan Chase & Co., American Express Co. and Chevron Corp. climbed at least 3%.
Even the commodities market is starting to have a brighter outlook. Consider the copper-gold ratio, which is generally seen as a barometer of overall economic health and risk appetite because the price of the former is a bet on global industrial growth while the latter is a favored haven asset. It fell earlier this year to levels last seen in the 1980s. It has since come roaring back, reaching a pre-pandemic high on Tuesday and further diverging from the level of benchmark Treasury yields, which it usually mirrors closely. Even when the ratio was much lower in early September, DoubleLine Capital Chief Investment Officer Jeffrey Gundlach said it implied the 10-year Treasury yield should be closer to 1.25% than where it was at the time, around 0.7%. (Note the chart below is of 30-year yields.)
Now, there are certainly reasonable explanations for bonds failing to embrace the return-to-normal program. For one, Treasuries are captive to actions from the Federal Reserve, while most others aren’t directly influenced by central bank policy. And Fed officials have made it clear that they won’t raise the fed funds rate “until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.” I’ve written before that the guidance is full of loopholes and vaguely defined terms, but suffice it to say that the U.S. economy is nowhere close to a point at which interest-rate increases are even a remote possibility.
So it’s little surprise, then, that U.S. two-year real yields fell on Tuesday to -1.4%, the lowest since June 2014. The Fed will almost certainly keep short-term rates near zero for the next few years, especially if President-elect Biden’s pick for Treasury secretary, Janet Yellen, needs rock-bottom rates to persuade Congress to pass more fiscal aid. Meanwhile, a coordinated monetary and fiscal policy might actually push prices higher.
It stands to reason that longer-term Treasuries will get the message eventually. One thing holding traders back from selling is the possibility that the Fed will announce next month that it has extended the weighted average maturity of its bond purchases. This, according to analysts, could be a way to offset any anxiety about the expiration of some of its emergency lending facilities after Treasury Secretary Steven Mnuchin asked the central bank to return funding last week. “The operating assumption remains that the FOMC is more likely than not to follow through with an extension of the WAM of QE purchases on December 16,” wrote Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets.
Perhaps ultra-low Treasury yields can persist even though there’s an end in sight to the pandemic economy and other markets make big moves. Plus, the Fed is still gobbling up $80 billion of Treasuries each month. But flat yield curves and low long-term rates would theoretically make it difficult for bank shares to sustain their rally. And negative real yields are often a catalyst to purchase gold, which could prevent the copper-gold ratio from skyrocketing even higher.
That doesn’t make it any less frustrating for bond traders waiting for a breakout.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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