Who's Afraid Of 1.3%?

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Investors today worry about the implications of the fact that 10-yr Treasury yields fell to a new all-time low of 1.32% this morning. Does it mean the Fed is too tight? Does it reflect a threat of deflation? Is the global economy on the verge of another recession? Are we on the cusp of a exploding debt bubble? Will we never see real growth exceed 2-3%? Are yields going to zero? Will US yields follow German and Japanese yields into negative territory?

If history is any guide, there's reason to cheer, not despair.

The previous all-time low for 10-yr yields was 1.39%, recorded July 24, 2012. Investors who bought the 10-yr that day and still hold it have received a total return of about 5.7%. Investors who bought the S&P 500 that day and held on - shunning the widespread fears of global recession and deflation that plagued markets four years ago - received a total return of 54%. Gold and commodity prices fell some 15%.

This should not be construed as a recommendation to put your life savings in stocks. It's merely to point out that the future doesn't always turn out to be as bad as the market expects. Sometimes it turns out to be much, much better, as has been the case for the past four years.

My best guess as to why yields are so low? It's simply that the market is very worried, and about a lot of things: quantitative easing, negative yields overseas, slowing growth, geopolitical tensions, bad fiscal policies, deflation, etc. The market may be right to worry, but it may also be wrong. In order for an investment in 10-yr Treasuries today to beat alternative investments, an awful lot of bad things are going to have to happen over the next several years.


30-yr Treasury yields also hit a new all-time low Wednesday:

In order to reverse the decline in yields, we'll need to see more optimism regarding economic growth and/or clear signs of rising inflation. Stronger growth, in turn, will require a return of confidence that would follow expectations of improved fiscal policy (e.g., lower tax rates, reduced regulatory burdens). The House under Speaker Ryan is moving in the right direction with budget reforms, but those won't pass as long as Obama has his veto pen and fails to grasp what is really needed to get the economy moving. As for inflation, we've seen a gradual rise in core inflation at the consumer level (2.2% year over year, and 2.4% annualized over the past six months), but broad-based inflation remains below 2%.