US bond yields could soon go negative: Strategist

It's an inevitable question: Could U.S. 10-year yields turn negative now that German 10-year yields have fallen below zero for the first time ever and Japanese 10-year yields have dipped to record lows of negative 0.17 percent?

According to Dennis Davitt, partner at Harvest Volatility Management and a noted options market veteran, it may well happen.

"I think you could see negative rates in the U.S. If Germany and other countries in the world go even further negative, it turns into a number line game. So where zero lies on the number line, who knows?" Davitt said Tuesday on CNBC's "Trading Nation."

He sees rates being driven lower by two factors in addition to overall slow global growth: Stimulative central bank policies and regulations.

"The European banks under their Basel regulations, much like our Dodd-Frank, are forced to hold a certain amount of assets on their balance sheet [and] those assets have to be government-issued debt. So they're forced to own those assets."

For that reason, no matter how low yields fall, "there's a buyer in the marketplace," he said.

As Davitt implies, there is a correlation among government bond yields around the globe. But there remains a big difference between the German and Japanese economies on the one hand, and the American economy on the other. According to the latest figures from the OECD, inflation in German is mildly negative, and Japan is also experiencing deflation; the same report, which looked at annual inflation in the year ending April, placed U.S. inflation at 1.1 percent.

Since bond yields without credit risk are generally thought to include an inflation-compensating component and a "real rate" component (which should relate to the general supply and demand for funds), the higher inflation in the U.S. means that the real rate has to become that much more negative before the zero line is crossed.

"Our bonds have been negative a long time in a real sense, but not in a nominal one," Max Wolff, chief economist at Manhattan Venture Partners, said Tuesday on "Trading Nation."

Wolff doesn't see a nominal negative rate around the corner due to his perception that "Americans have more of a risk appetite than either Japanese or German investors," meaning that American investors will be more inclined to buy stocks rather than extremely low-yielding bonds.

Negative rates are an exceptionally odd condition that is hard to wrap one's head around. What a subzero yield means in practice is that if a bond is held to maturity, one will receive less than a full dollar back for every dollar invested. Lending one's money in such conditions may sound insane, but could make sense in cases when one needs assurance of receiving a given sum of money, which is an assurance that only government bonds can provide (and even then, only if one assumes there is no chance of the government defaulting).

Other strategists, like Larry McDonald of ACG Analytics, say negative U.S. yields are unlikely, since central banks around the world will soon change course due to the failure of the policies to spur growth.

The U.S. 10-year Treasury yield fell below 1.6 percent at one point on Tuesday, nearly matching the multiyear rate lows seen in mid-February.

Federal Reserve policymakers are expected to announce their latest interest rate decision on Wednesday.


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