Stocks are sailing higher as Brexit worries fade, but the global bond market is signaling that there's plenty to fear.
Bonds have been on fire globally, as investors rush to snap up safety, particularly at the long end, and that is sending yields to new lows — and some yields even into the black hole of negative rates. The U.S. 30-year Treasury bond is closing in on its all-time low yield of 2.223 percent.
"I think people are hunkering down and buying bonds because of the uncertainty in the world. They want to be able to sleep at night," and Andrew Brenner, head of international fixed income at National Alliance. Brenner said in the U.S., 20-year corporates and 30-year Treasurys were the hot spots in Wednesday's market.
While investors may be frustrated by the low yields, consumers are the winners, with mortgages and a whole host of loans heading lower.
Bond yields move inversely to prices, and that market was trading at rich levels well before the Brexit vote. Investors globally have been responding to yields driven lower by central bank buying and easy policies, such as the negative rates set by central banks in Europe and Japan.
At the same time, investors worry about the strength of the global economy and the fact that central bank easing has been unable to jump-start growth. But the U.K. vote to leave the European Union has driven a new belief that global interest rates will now stay lower for much longer than was previously expected.
"Already heading into the vote, the Fed was concerned about a whole mass of concerns. Now you've just added a shock," said John Briggs, head of strategy at RBS. Briggs said financial conditions have tightened slightly but are not now a worry. "You had a Fed that was already worried about the economy and global forces. You just added another one."
The U.K. divorce from Europe is projected to be a long process, and the lack of details and heightened uncertainty is expected to hinder the Fed from raising rates and keep other central banks in easing mode. There are also additional political risks in the offing, with other elections across Europe, particularly France, that could show unexpected strength among nationalist parties.
The surprise pro-Brexit vote also hit a bond world that already has about $11.7 trillion in negative-yielding debt, according to Fitch's latest data. The vote was an added jolt that propelled yields to new lows.
On Wednesday, the 10-year U.K. gilt was just above its post-Brexit low at 0.95 percent, and the German 10-year bund was yielding a negative 0.13, above its Friday low of minus 0.17. The U.S. 10-year rose slightly to 1.47 percent, but the 30-year Treasury yield continued to head lower, at 2.26 percent.
"What got us here is Brexit news, and what's keeping yields here is a level of skepticism that this is not over and, if this is a long-term issue, then rates won't go up for a long, long time," said George Goncalves, head of rates strategy at Nomura. Stocks Wednesday were reflecting more optimism that a Brexit won't be disruptive to the global economy.
"I think the bond market still remains skeptical that this kind of bounce back (in stocks) is nothing more than a dead cat bounce, and I think that's likely so," he said. "On the one hand, this obviously is a political risk and has longer-term economic considerations." Goncalves said it's not clear yet whether it will become a financial risk.
Some of the buying is quarter-end positioning, which has also been positive for stocks. The absence of action in the U.K. as it begins the process of finding a new prime minister has left a void of activity, where some in the markets are now speculating that perhaps a Brexit may not even happen.
In order to start the long, two-year process of separating, the British have to officially trigger Article 50, under EU rules. But that trigger is not expected to be pulled until a new prime minister is named in September.
"There's probably some window dressing involved. I think at the end of the day, whether the Brexit gets reversed or not … or how it plays out or whether the British implement Article 50, it puts a lot of uncertainty into the marketplace," said Brenner.
Expectations for Fed rate hikes have fallen so much that now the first rate rise is not priced into the fed fund futures market until 2018. Just weeks ago, the U.S. central bank was expected to hike rates this summer.
Economists predict that a Brexit could shave about 0.2 percent off of U.S. growth in the second half of the year, but for the U.K. it could mean recession. The fear for the U.S. is that if it were to cause financial conditions to tighten significantly more, that would hurt the economy.
The U.S. economy has been viewed as strong enough for the Fed to slowly raise interest rates, and U.S. yields are higher than global counterparts, but they are getting dragged lower by investors finding better value in Treasurys than the negative-yielding Germany and Japanese debt.
Briggs said yields could still fall, but they don't have to move much lower. "I do think it's going to be harder and harder to press them down. We are higher yielding than the world, but we have a higher inflation rate and a higher policy rate. I do think the bias is for lower yields," Briggs said. "We're still in the process of exploring the lower end of the yield range, because investors are adjusting to a new world."
The reach for yield has sent investors into the long end of the U.S. Treasury curve, and there has also been a rush into 30-year swaps, causing rates to fall to 1.77 percent, a record low, said Brenner. Swaps are derivative instruments used as a proxy for getting exposure to the long end of the U.S. rates market.
Investors are adding duration globally. In Japan overnight, buying in the 20-year Japanese government bond sent that yield to a record low of 0.39 percent.
"There's no way the Fed can do anything but wait. If they're going to wait, why are interest rates going to go up? They're just going to grind lower," Brenner said. "