U.S. bond yields are likely to stay at record lows—and could move even lower—until European policymakers convince markets they have a grip on the potential contagion threatening the euro zone's banking system.
As buyers continued to rush into the safe haven of bonds Wednesday, the 10-year Treasury yield, in an inverse move, fell through its September low of 1.671 percent, and was yielding below 1.63 percent. The euro was nearly a percent lower against the dollar, which has become a magnet for funds seeking safe haven assets.
“It all focuses the attention on the fact that there isn’t a cohesive plan to deal with institutions in Spain and in Europe that are experiencing deteriorating assets at the same time they are trying to deleverage their balance sheets,” said Zane Brown, Lord Abbett fixed income strategist.
European Commission officials Wednesday offered Spain more time to reduce its budget deficitand direct aid form a euro zone rescue fund so it can recapitalize its troubled banks.
The European Union also suggested a plan to help the financial system. The EU executive office said the 17 countries in the euro zone need a “banking union” that can oversee the system centrally and provide bailout assistance, if needed.
“This is a 'get out of the way' type moment, where people just want to see where the dust settles. We broke through the all-time records of intraday moves and definitely will end of day. This is a reflection of how much fear is in the market and some benefit of the money coming to the U.S.” said Nomura Americas Treasury strategist George Goncalves.
Goncalves said the 10-year yield could fall as low as 1.5, but he expects it to hold 1.6 percent if U.S. economic data, especially the May government jobs report on Friday, continue to hold up. Stocks were down more than a percentin midday trading.
Goncalves said the low 10-year is also the result of European institutions seeking an alternative to the German bund, which is also yielding a record low 1.26 percent.
“Spanish default risk is higher today,” said Brown. “We saw their 10 year exceed 6.6 percent, knocking on the door soon of that 7 percent level that led Greece, Portugal, Ireland to get aid from the EU and the IMF.”
Brown said the big drop in the euro from a recent $1.32 to below $1.25could continue, and that would draw more investors who fear currency losses overseas into Treasurys
“It all suggests the U.S. is a pretty decent place to put money, even with growth of 2 to 2.5 percent. It seems predictable and sustainable, at the same time, and the currency doesn’t seem like it will lose value so even though you get minimal return, and even negative return, after inflation, it makes sense for global investors to go into the 10-year,” Brown said.
Markets have been concerned that Greece, facing an election June 17, would select candidates that would ultimately take it out of the euro zone. The big fear was that Greece’s exit would be sloppy, creating bank runs in other weak sovereigns and ultimately resulting in a breakup of the euro zone.
European officials should do something similar to the quantitative easing carried out by the Fed, and they are instead tackling the problem with a piece meal approach, said Goncalves. “They need to have a counter punch of massive size now…they were doing small can kicking. Now they need to really punt the big can,” said Goncalves.
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