Long-term Treasury yields’ rapid decline has been one of the most baffling market developments of 2019.
The 10-year Treasury yield fell 38 basis points (0.38%) in May, its biggest monthly drop since January 2015. The benchmark yield is now hovering around a 20-month low.
We’ve seen several interpretations of Treasuries’ cautious undertones recently—one of them being the idea that bonds could be forecasting economic weakness that other financial markets are missing.
“One of our biggest challenges this year has been explaining a bond market that’s become increasingly pessimistic on the economic outlook,” said LPL Research Chief Investment Strategist John Lynch. “In any case, we encourage investors not to get too caught up in Treasuries’ cautious signaling. We see plenty of evidence that solid U.S. fundamentals remain intact, and we don’t think yields’ recent decline is simply an indictment of future economic growth.”
To be fair, there is evidence of weakness in economic data. Data on durable goods orders, industrial production, and manufacturing activity continue to trend lower. However, the bulk of economic fundamentals don’t support a 10-year yield nearing 2%. Output growth hasn’t slowed noticeable, wage growth is healthy, and the U.S. labor market is close to full employment.
We also haven’t seen signs of stress in other fixed income indicators. The spread between the 2-year and 10-year yields remains squarely in positive territory, and corporate debt spreads have been relatively contained. We’d expect to see more deterioration across credit markets if a recession were imminent.
We think the most plausible explanation for the decline is that intensifying trade and political risks have ignited a wave of panic buying in U.S. debt, a trend we expect to reverse as trade risk subsides. However, a protracted trade dispute could further weigh on growth, so we’ll continue monitoring economic data for vulnerabilities.
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