End in Sight? Bond Yields Continue to Hit Record Lows
U.S. bond yields continued to hit fresh lows on Thursday, driven by weaker U.S. economic data.
The 10-year Treasury yield fell below 1.55 percent after disappointing jobless claims data and a weaker first quarter GDP reading spurred a new spree of flight-to-safety buying. Disappointing Chicago PMI was also a factor.
Rates had already fallen into record territory Wednesday on worries that European policy makers will not act swiftly or definitively enough to stop the spread of contagion from the European sovereign debt crisis.
The latest concerns focus on Spain's troubled economy, its budget deficits and its weakened banking sector.
Jobless claims rose to 383,000, above the expected 370,000. ADP's private sector employment report also showed 133,000 jobs added in May, below the expected 150,000. Both numbers were considered important previews for Friday's government employment report, expected to show 150,000 nonfarm payrolls were created in May.
"I think the higher than expected claims print, coupled with upward revision of the prior week is consistent with the notion that the prior gains we had seen in employment at the beginning of the year will prove to be unsustainable. This definitely skews lower the expectations for tomorrow's number," said Ian Lyngen, senior Treasury strategist at CRT Capital.
Mesirow Financial chief economist Diane Swonk reduced her expectations for May payrolls Thursday morning to 125,000 from a prior 150,000.
The 10-year Treasury yield, in an inverse move, fell through its September low of 1.671 percent as buyers rushed in to bonds Wednesday. The euro was slightly higher Thursday, but its recent trend has been 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...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 1.50. On Wednesday, he predicted it would hold the 1.60 level if U.S. economic data continued to hold up.
First quarter GDP was reported Thursday to have increased 1.9 percent, down from the prior reading of 2.2 percent. While expected to decline, the report also showed that after-tax corporate profits declined for the first time in three years.
"That's going to have implications for corporations' willingness to invest in property, plant and equipment and hiring, going forward," Lyngen said.
While the Fed is not expected to act at its June meeting, market chatter already focused on new Fed actions if the employment report continues to be shakey
"I think the Fed is sitting on their hands, saying 'Okay, the market is easing for us,'" said Lyngen, but he added there is a chance the Fed could take further easing moves later in the year.
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 1.219 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.” The Spanish yield recovered slightly to 6.5 percent Thursday.
Brown said the big drop in the euro from a recent $1.32 to below $1.24could 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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