The surprise fall in 10-year Treasury yields could continue. Here's what it means

Published Wed, Jul 7 20212:22 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

The benchmark 10-year Treasury yield has fallen into a surprisingly low range and is defying the widely held view that interest rates were on a one-way march higher. The 10-year yield dropped as low as 1.295% Wednesday, the lowest level since mid-February and well below the 2% or more many strategists expect by the end of 2021. The yield was at 1.32% after the Fed released minutes from its last meeting. Now instead of seeing a bounce higher, investors are eyeing a chart pattern that puts the 10-year yield closer to 1.2% before it would reach a place where it might stop falling. "It's a repositioning of some of the macro trades that were out there," said Jim Caron, head of macro strategies for global fixed income at Morgan Stanley Investment Management. The 10-year yield had been moving higher earlier in the year, touching 1.75% in March , as investors bet on more inflation and an economy that would be firing on all cylinders. Slower growth ahead The second quarter was when growth was expected to peak, and now investors are looking ahead to a period of slower, yet still strong, expansion. According to CNBC/Moody's Analytics Rapid Update of economists' forecasts, the median outlook for growth in the second quarter is a 10.5% pace, while the third-quarter forecast drops to 8% and the fourth quarter is at 6%. Economic reports have generally been strong, including June's employment report with 850,000 payrolls . But June's ISM services index fell by more than expected and rattled the bond market Tuesday. It was reported at 60.1, down from 64 in May. However, the employment component fell to 49.3, a sign of contraction. "What we're realizing is the data is going to be good, but the question is, is it good enough? The market says it's not," Caron said. "We had this exceptional ramp up in monetary policy, fiscal policy...I think people are unwinding some of those macro reflation trades...Normally, this would mean 'oh my God, it's all over.' I don't think it is." "I think we have to repace ourselves or reset ourselves from the push in growth and inflation coming from the fiscal side to the private sector," he added. "This is the hand-off of the stimulus from the public sector to the private sector. It's all about demand now being generated by the private sector." Bond purchases picked up Bond yields move opposite price. Strategists say the buying picked up steam around the end of the quarter as investors reassessed the reflation trade. The sharp drop in rates is being driven by repositioning, short covering and foreign demand. Rates in Europe are also falling. The 30-year yield, at 1.93%, has also been falling sharply, but the 10-year is the most watched of the Treasury yields because it is the benchmark and influences mortgages and other loans. Caron said a positive is that the credit markets have benefitted and yields on high-yield corporate debt have fallen. The 10-year yield is also closely linked to the stock market, In recent months, it has served as a kind of divining rod for tech and other growth stocks. When the 10-year yield moves lower, tech and growth tend to outperform. "It's seismic. This is a huge wake-up call," said George Goncalves, head of U.S. macro strategy at MUFG Securities. He said there are a range of different types of investors in Treasurys, and some "accounts did not have in their annual forecast that we were going to 1.20% before we got to 2%." That has caused many investors to scramble and add to positions. Goncalves said investors held on as the yield fell below 1.6% last month, and then 1.5% and 1.4%. That pushed investors to buy Treasurys to cover their short positions. "There's pain involved right now. There's something that's going on that's forcing peoples' hands. There's a disbelief that we would not stay meaningfully under 1.50%, much less 1.40%," Goncalves said. "People were holding off, expecting this recovery going on. Once we broke that, it probably drove a lot of investors to rethink their fixed income allocations. Investors had been underweight." Goncalves adjusted his year-end call for the 10-year yield to 1.75% from 1.875% on Wednesday, but he expects the decline to stop soon. Some strategists have been anticipating market turbulence when the Congress addresses the debt ceiling later in the year, but Goncalves said it's too early for the market to reflect that. "People were just super optimistic. That's all it really is. It's been proven that the Treasury is not the optimal way to put on a trade on the economy improving," he said. "It has limitations about how far it can go unless the Fed is hiking and they're not." Strategists say there is a 1.21% to 1.22% level on the 10-year yield chart that they are watching. "If it can reach 1.25%, there's little to stop it from going there," said Ian Lyngen, head of U.S rates strategy at BMO Capital Markets. "We're setting a lower rate range with very little on the macro front to deter a continued grind."

Carlo Allegri | Reuters

The benchmark 10-year Treasury yield has fallen into a surprisingly low range and is defying the widely held view that interest rates were on a one-way march higher.

More In Pro Insight

The market is rallying. Maybe that's partly due to panic buying

Bob Pisani6 hours ago

Never before have two CEOs had so much sway over the entire stock market

Patti Domm

The summer rally has been very bullish, but strategists say a big sell-off next month is possible

Patti Domm

The surprise fall in 10-year Treasury yields could continue. Here's what it means

More In Pro Insight

News Tips

Advertise With Us