Sovereign bonds are pricier than ever, yet the world can't seem to get enough.
The rush into bonds has been due to a number of factors, including worries about global economic growth and most recently fears the U.K. could disrupt financial markets and the economy if it votes next week to leave the European Union. But the overriding forces behind the buying are the world's central banks as well as the unease caused by the world's central banks.
"The central banks are Hoovering up all of these bonds. But yet it hasn't promoted growth or inflation," said George Goncalves, head of rates strategy at Nomura. "Maybe these policies are not effective. That new theme, which has been growing throughout 2016, is: 'Those guys can't generate growth and help the world economy. I have to buy bonds.'"
As prices rise for government bonds, yields fall, and this week some yields, like German 10-year bonds and Swiss 30-year bonds, went negative for the first time ever. Drawn to these low yields like a magnet, the U.S. 10-year fell to a low Thursday morning of 1.51 percent, close to its all-time low near 1.39 in July 2012. It rebounded as bonds sold off later in the day to 1.57 percent.
"They thought they'd be easing us into buying other things by providing liquidity. Instead, people put money to work to fixed income and it created a negative feedback loop. Basically, they thought it was going to be virtuous and you'd see growth and more lending, and instead they're making people buy the same thing they're buying," said Goncalves.
On Friday, markets will be watching housing starts in the U.S. at 8:30 a.m. but will more so be monitoring developments in foreign markets. The reversed course Thursday and ended higher after U.K. sterling rose and gold erased much of its gains. The move coincided with news that Britain temporarily suspended campaigning on the Brexit vote after a member of Parliament was shot and killed. The cause of the shooting was unclear, but there was speculation the act could encourage more voters to choose to remain in the EU.
Some of the tension in markets could end if the Brexit vote to leave Europe fails June 23, as Thursday's market reaction showed.
"There is a little bit of psychology here, I think, that's at work. You don't want to miss a rally, but you also don't want to get hurt if there is an adverse outcome. It does make it very, very tricky, but what it really means is today in portfolios, people are building high levels of cash because they're reducing risk, but what does it mean if it's a risk-on event after the 23rd? There is a lot of cash on the sidelines that needs to be put to work and it could chase the market higher," said Jim Caron, fixed income portfolio manager at Morgan Stanley Investment Management. "There's also a significant amount of money that's on the sidelines right now that will act as a stabilizer."
If the U.S. 10-year does fall through its all-time intraday low 1.36 percent, set in July 2012, most strategists don't have a forecast that low, and some say it could keep on falling. They do say if the British vote fails to support a separation from the EU, yields could adjust upward. But because the current move lower has been based on relative value, charting levels with traditional technical analysis is not as useful.
"What recent history has shown us is you cannot definitively say there's a level in rates that cannot be breached," said Goncalves.
The actions of central banks have been perplexing, and in fact they are becoming a fear factor themselves. The Federal Reserve is the one bank trying to go against the easing trend, and it caused a bit of an uproar in markets this week when it reversed course on its interest rate forecast, stepping back from more than one hike this year and paring back on the number of increases for next year and the year after.
"You have the confusion coming from the reaction, response to the Fed, after two weeks ago they set up the market for a rate increase," said Mark Luschini, chief investment strategist at Janney Montgomery. "There's unevenness, waffling or the inconsistency of the reporting coming out of the Fed. … You had the Bank of Japan … based on the strength of the yen, was poised to act and it sat on the sidelines, rallying the yen even further. That's disturbing based on the implications for the Japanese economy."
Luschini said investors are becoming worried about overreach by the central banks. There was also some concern after Wednesday's Fed meeting that the Fed felt it needed to reduce rate forecasts, just to maintain its already low economic forecasts.
"I think the legitimacy of Fed policy or central bank policy, whether it's impotent or not, is coming to the forefront as a question in investors' minds," said Luschini. "The Fed is talking about an event [Brexit] that didn't even happen yet. They focus on a date on a calendar for an event that could occur but has not occurred, and they're acting in anticipation of that and are again becoming the world's central bank."
Yellen said Brexit factored into the Fed's thinking when it met this week, and Bank of Japan Gov. Haruhiko Kuroda said he had been in contact with the Bank of England and other central banks about the risks of a Brexit. He blamed Brexit talk for the declines in Japanese government bond yields to record lows, and he acknowledged the risks from the yen's sharp rise.
Even though the BOJ already took interest rates negative, the market speculated it could make other moves at Thursday's meeting such as increasing its asset purchases, similar to the corporate bond buying program started by the European Central Bank last week. So the response was great when it failed to announce new policy, and Japanese stocks ended down 3 percent.
David Ader, chief Treasury strategist at CRT Capital, said the U.S. 10-year yield is being tugged lower, mostly due to interest rate differentials, with the Japanese and German 10-year now at negative yields. Ader said the differential between the U.S. 10-year and German bund when the 10-year was at this level in 2012 was much narrower than the current 1.55 differential. That level has been close to zero.
"With bunds where they are, we could go to 1.00 percent in 10s and still maintain a wide differential," said Ader. "If you connect that we are being driven by these overseas issues then yes, it's ridiculous but it's not only about the U.S. in that context, we can go lower."
Fed Chair Janet Yellen is scheduled to testify before Congress for two days next week, and her comments will again be critical to markets trying to decipher the Fed's message.
"I'm just worried about what this means for the state of the world when you have rates grind lower and people are questioning the efficacy of central banks," said Gonaclves. "To me, the bigger issue at hand is we don't have a sustainable way to create upward growth."