U.S. Treasury yields have been falling for quite some time, as we are in a middle of a bull run. In other words, as investors and asset managers continue to buy bonds, yields are moving lower. Right now, Treasury yields are not far from their 11-month lows, and we could see them fall even lower. There is a slight chance that they could match Japanese Government Bonds' (JGB) persistently low yields at some point.
Wherever we seem to look, yields are shocking low. There is a chance they could move even lower. We look at the United States, Germany and Japan, three powerhouse economies that will not default anytime soon. However, they are going to keep interest rates super low or near zero for the next year, or even two. This means the risks are the same whether you are talking about bunds or U.S. treasuries. Asset managers tend to buy higher-yielding instruments, and as they do this, there is a chance rates could move to the JGB level. At least in theory.
Let us look at the following example: an asset manager is sitting on a large sum of money in a pension fund, this asset manager is not going to risk this position by putting it into a bank. They are looking at bonds. U.S. bonds pose the same risk or better as the average commercial bank, so taking 2.5 percent versus zero is a good trade.
Since the Federal Reserve (Fed) commenced tapering its massive asset purchase program, rates have not moved they way they should have. Instead of rising, rates declined. The ten-year Treasury bond is now near 2.44 percent, which is near an 11-month low. In January, the rate was at three percent, and in early trade today, at 2.61 percent. This is still well above the 10-year JGB rate, which is below 0.60 percent. The 10-year JGB has not traded over one percent in over two years. They hit one percent, and briefly above in mid-2012. German bunds are not much different. The 10-year rate is near 1.36 percent, and we have not been above two percent since last September.
However, this notion that Treasury yields are going to keep falling and match the level of the JGB is not like to happen. Why? The growth trajectory is different. Japan has yet to really recover from two decades of low inflation and stagnant growth. On the other hand, there are real signs the U.S. economy is recovering. This is obvious from last week's non-farm payroll report (NFP), as well as other strong data released over the last 10 days. If you recall, the NFP showed that the U.S. economy added 217K new jobs in May, and the unemployment rate was steady at 6.3 percent. Still, the U.S. economy is not all the way back yet to pre-crisis levels, as we are around eight to nine million jobs short.
Japan's economy is not necessarily an underperformer, and is being held to a high standard. Their economy grew to the world's second-largest, then slipped back to third place. The notion that their economy will get back to where it once was is a fallacy, as their population is declining and aging. There is also a slowdown in productivity.
There is another reason why Treasury yields are unlikely to fall two more percentage points to match JGB rates. U.S. rates have never been in that area. The lowest yield we saw was at 1.5 percent. This was when the Fed enacted its latest round of QE. The Fed is tapering this program and will end it sometime in mid-October, as long as the data keeps showing the economy is accelerating. Sooner or later, the Fed will normalize rates, and this is likely to push Treasury yields higher.
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