This is what is keeping bond yields low

Leslie Shaffer | Writer for
Trader on the floor of the New York Stock Exchange, May 21, 2014.
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Bond yields have stymied widespread expectations they would rise this year and analysts seeking a reason may not need to dig any deeper than simple supply and demand.

(UPDATE: On Wednesday, Treasury yields dropped to 2014 lows).

"On the supply side, bond issuance plummeted, down 19 percent year-to-date. Amidst short supply, a surge in positioning and bond inflows has pushed yields lower," Deutsche Bank said in a note last week.

It noted U.S. Treasury net issuance is around $123 billion year-to-date, down 59 percent from a year earlier, while net issuance of corporate paper and mortgage backed securities has also fallen.

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At the same time, "on the demand side, bond futures positioning was short coming into 2013 and has now turned very long, led by hedge funds," it said. "Although the Federal Reserve reduced purchases, foreigners, U.S. banks and pensions increased their bond buying."

Analysts had widely expected interest rates would rise as the Fed began pulling back its asset purchases in January and as investors shifted out of bonds to seek more risk in equity markets.

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Instead, the 10-year Treasury yield has been hovering around 2.5 percent, down from around 3.0 percent in January. (It fell below 2.45 percent Wednesday). Bond yields move inversely to prices. In addition, around $85.52 billion has flowed into bond funds so far this year, outpacing the $45.98 billion that flowed into equities over the same period, according to data from Jefferies.

But Deutsche Bank doesn't expect yields will necessarily remain low. Over the past few years, positioning in bonds has inversely followed growth in gross domestic product (GDP), it noted.

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"After zero first-quarter GDP growth, investors went long bonds with a surge in rates positioning and bond inflows," it said. "So a rebound in growth, as is consensus, would see long positioning reverse, while Fed (Federal Reserve) QE (quantitative easing) is set to end."

In addition, it expects net U.S. Treasury issuance will be around three times the January-to-May pace, based on the Congressional Budget Office's estimates, while at the same time, corporate issuance is likely to pick up as acquisition deals are finalized.

Bubble in bonds?

To be sure, some believe the low bond yields have a more traditional macro-economic cause.

"U.S. bond yields are low because growth and inflation are low, not just in absolute sense, but also relative to expectations," JPMorgan said in a note last week. U.S. economic growth expectations rose steadily from May to December of 2013, and then fell back quickly this year, it noted.

The current economic recovery in the U.S. is the weakest since World War II, it noted.

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"Lower growth pushes bond yields down, and countries with disappointing growth will see yields falling versus countries with better growth," it said.

But even as yield levels fell this year, they didn't go as low as the year-ago levels as the first Fed interest rate hike is a nearer event, JPMorgan said. In mid-May of 2013, before the Fed first broached the idea of tapering its asset purchases, the 10-year U.S. Treasury was yielding around 1.60 percent.

Like Deutsche Bank, JPMorgan expects bond yields will pick up later this year.

"Relief that the second quarter is picking up from the first quarter, both in the U.S. and globally (ex Japan), is set to put some upward pressure on bond yields," JPMorgan said. But it doesn't expect a big climb in yields until the Fed gets closer to its first rate hike.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1