Behind the Money

Bonds Signal 2nd Anniversary of Recovery Could Be Its Last

The economic recovery turned two years old this month, yet some investors continue to pile into government bonds and forego stocks and other investments typically popular at this stage of a comeback. So much so that traders are running out of reasons to explain away the bottom basement bond yields that inexplicably continue to attract more investors.

Traders work in the ten-year U.S. Treasury Note options pit at the Chicago Board of Trade in Chicago, Illinois.
Daniel Acker | Bloomberg | Getty Images

The 2-Year Treasury note is up 10 straight weeks for its longest winning streak since 1986. The 10-Year note, a benchmark for rates on everything from auto to housing loans, is up for five straight weeks. With the 2-Year yield at about 0.37 percent and the 10-year returning 2.96 percent, these investors seem content with basically a negative return when taking into account inflation. They are paying the government for the privilege of protecting their principal.

The bond rally “has to be causing the growth bulls just a little bit of discomfort,” said David Rosenberg, chief economist and strategist for Gluskin Sheff, in a note. “This should not be happening if, in fact, the current slowdown is a mere temporary ‘soft patch.’”

The recession ended eighteen months after it began in June 2009, making it the longest downturn since the Great Depression, according to the National Bureau of Economic Research.

Other than a double dip, three theories emerge to explain these extraordinary moves in bonds: 1) a safehaven bid on Greece fears; 2) purchases by the Federal Reserve distorting Treasuries as a predictive mechanism, or 3) banks flush with cash temporarily parking it in fixed income.

Treasuries did fall Tuesday as Greece looked to be headed towards a resolution, but investors must not believe Greece was the sole problem because the 10-year still remained stubbornly below three percent. The latest reading from MIT’s Billion Prices Project puts annual inflation at around 3.5 percent in this country.

“The basis for the low yield is both the flight to safety and the coming slowdown in the major economies of Europe, Japan, and the US,” said Sean Egan, operator of the self-named ratings service credited with predicting the 2007 crisis.

The Fed will end its purchase of $600 billion longer-dated Treasuries at the end of this month. If Bernanke, who faces the press again during a monetary policy conference on Wednesday, is sticking with this end date, then why aren’t rates rising in anticipation of this? Some argue that Bernanke will announce another creative way of stimulating liquidity.

“Try double dip and then triple dip,” said Peter Schiff, President of Euro Pacific Advisers “As long as we get stimulus, any ‘recovery’ sows the seeds of its own destruction.”

As for that third excuse on banks, Gluskin Sheff’s Rosenberg and others point out that even though banks are not explicitly making a directional bet by loading up on Treasuries, doesn’t the fact that they are buying government bonds instead of lending to consumers say enough about their true outlook on the economy?

To be sure, the S&P 500 is off just six percent from its bull market high hit in late April of this year. A weaker-than-expected May jobs report and a string of weak economic data since then has caused equity investors to take some profits, but nothing compared to what would take place if they felt an economic retrenchment was ahead.

“Corporate earnings, up almost 20% year-over-year, will prevent a double dip recession,” said Joe Terranova, chief market strategist for Virtus Investment Partners and a ‘Fast Money’ trader. Terranova’s been looking to add to some stock positions amid this pullback.

But how can bond investors be hunkering down for the worst, yet stock investors just casually taking profits? Market observers can’t remember a time when there was such a divergence between the so-called predictive mechanisms of the two markets.

Rosenberg has an explanation.

“The difference between the stock market and the bond market is that when the former puts together a string of rallies, market commentators are all over it and urging the general public not to let the train leave the station without coming on board,” wrote Rosenberg. “But if the bond market retains a positive tone, the pundits always claim it is the sale of the century.”

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