Here’s why U.S. Treasury Yields are dipping

Kathy Jones, Chief Fixed Income Strategist at Charles Schwab, joins Yahoo Finance to discuss the moves in the bond yields, Fed meeting expectations, and outlook on inflation.

Video transcript

ALEXIS CHRISTOFOROUS: I want to bring in Kathy Jones now, Chief Fixed Income Strategist at Charles Schwab. Kathy, great to see you. So I've got this question for you that seems to be having a lot of investors scratching their heads. If we have a strong economy-- this economic recovery seems to be firing on all cylinders-- inflation is also up-- why are bond yields so low?

KATHY JONES: Yeah, that is the question of the day that we get from clients all the time. And as much as I'd like to give one simple answer. I think it's a combination of factors, some technical and some fundamental. So on the technical side, you know I think we have a lot of investors off sides. But early in the year, in the first quarter, they were too bearish on the bond market. And they had to flip around when the economy did so much better than expected, and yields went up.

I'm sorry-- they were too bullish on the bond market. Yields went up, and they had to flip around. They got bearish. And of course, then, high yields have come down. So there's some of that. There's some liquidity effect as well. So we have still a tremendous amount of liquidity, not just domestically, but globally supporting the bond market. And some of that is just being recycled into treasuries.

But I think from a fundamental point of view there's a couple of stories that make sense to us. There's the peak growth concern. So we've seen these very strong numbers in the second quarter on a year over year basis. But I think everybody knows that we're not going to see the same sort of numbers repeated in the third and fourth quarters and beyond. So, for example, you're not going to see all of this pent-up demand is getting satisfied to a large extent. So we're not going to see these are double digit increases in order flow. In fact, today's capital goods numbers, the durable goods numbers, show that things have sort of settled down there.

Similar story on inflation. Although it's up and it's likely to stay elevated for a while, we're not going to see used car prices increase 10% every month going forward. There is a point at which prices fix the problem of high prices. And people just resist. So as we look forward, a lot of people are looking at it and saying, well, look, we've seen the peak in demand. We've seen the peak in growth. It's on its way down.

And then we've got the Fed at some point hinting that they might tighten policies for tapering. And that sends a message that they might cool things down, down the road. So all of that combined is sending the message that the future doesn't look like the current situation. It may look slower with lower inflation and lower bond yields.

KRISTIN MYERS: Kathy, I'm curious to know what you think might be a catalyst at least to the upside for yields going forward.

KATHY JONES: Well, I think a couple of things. So one will be if the economic data surprises on the upside for a change. So we've kind of flipped from first quarter to second quarter. If third quarter flips back, and the economic surprises are on a strong side, that could be a possible catalyst, along with global growth. So we are starting to see some better numbers globally. It's been offset by concerns about China and what's going on, as we mentioned earlier, with the regulatory side there. But if we were to see global growth pick up, that would definitely, I think, make a difference.

The other thing, of course, is inflation. So if inflation numbers don't back off pretty soon, we may need to build in more of a risk premium for inflation. And finally, if the Fed is-- this is kind of ironic, but if the Fed signals it's going to stay easy for longer, that'll likely raise bond yields because that would signal a higher tolerance for inflation than I think the market believes the Fed will have.

ALEXIS CHRISTOFOROUS: All right, we're going to have to leave it there. Kathy Jones of Charles Schwab, thanks for being with us.