Investors have been flooding the bond markets, sending prices higher and yields tumbling.
The yield on the US 10-year Treasury bonds fell to its lowest since the October 15 meltdown across markets. The 30-year yield fell to the lowest since July 2012.
For Gluskin Sheff’s David Rosenberg, the demand for bonds that’s causing their prices to rally may be the beginning of a bubble. Bond yields fall when prices rise.
“I continue to marvel at the bond bulls that openly lament how overvalued the stock market is when it is their own bubbly market that is the prime reason for whatever valuation excess there may be,” he wrote in a note Monday.
In explaining this unprecedented demand for bonds, Rosenberg asked the following question:
“If I told you that the US economy would be closing the year running at its fastest pace in 11 years and that employment would be rising at the most pronounced pace since the 1999 boom, would you really believe that 10-year T-note yields would be hovering near 2.1%?”
The likely answer to that is no, because the two sets of scenarios typically do not add up. But as he also notes, a combination of conditions has sent investors to the perceived safety of US bonds, pushing up their prices and plunging yields.
Because the US budget deficit fell, the net new supply of bonds coming onto the market also fell. Central banks scooped up to 90% of the US government debt up for grabs at the same time. An increase in the population of baby boomers needing a steady and secure source of income has also boosted the demand for bonds. Similarly, pension funds everywhere are also looking for less risk.
In other words: the new supply hasn’t been big enough to meet demand.
Lower yields are great for consumers through lower borrowing costs and they supported the rally in stocks last year. But Rosenberg warns that “yields at these levels do not seem sustainable.”
Moreover, Rosenberg notes that for the Fed, low yields signal that there’s still weakness in the economy that warrants accommodative monetary policy, but major economic indicators suggest otherwise.
“While the FOMC did trim its near-term fed funds rate outlook at last month’s policy meeting, it left the terminal rate view at 3.75%. That is the cost of carry and so long as that is what the Fed believes, it is truly difficult to believe that down the road, the Treasury curve can continue to trade at such a huge discount to the overnight rate.”
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