10 Year Bond Yields

[Viking]

Over the years I have read many times that if you want to understand what is going on in the economy you should pay attention to what is going on in the bond market (more so than the stock market).

 

The yield on the US 10 year bond is now trading at 2.66%. Gundlach, in his last conference call said the key level, from a technical perspective, was 2.63%. He said if this level was breached, one could call an official end to the bull market we have seen in the 10 year bond for the past 30 years. Gundlach also said once 2.63 is breached 3.00% is the next level to watch and rates will likely move up towards this level over 2018.

 

Gundlach also called for the S&P to finish the year down in 2018 (which is quite the gutsy call given everything that has happened the past 14 months): after a strong start, as the 10 year moves close to 3.00% he expects stocks to sell off later in the year as higher bond yields (and the threat of even higher bond yields in 2019) eventually starts to factor into stock market valuations.

 

Buffett has said many times that he does not feel the stock market is expensive when the US 10 year treasury was yielding In the low 2% range. I wonder what he will say when the 10 years is yielding 3 or 3.5%?

 

If bond long yields continue to move higher my base forecast is we are going to get a lot more volatility in the stock market. If the 30 year bond bull market is indeed dead then we are entering a new world for investors. Might be good to raise some cash if stocks continue their parabolic ascent. Sounds to me like the bond bell is starting to ring :-)

 

PS: Fairfax looks to be positioned pretty well if 10 year yields move a lot higher :-)

[Cigarbutt]

When you look at the interest rates (ie US 10 yr bond) trajectory in the last 30 to 40 years, the trend cannot continue unless interest rates become negative. ???

It may be reasonable to expect higher interest rates going forward. But cannot offer a "base forecast".

 

With all this talk about relative valuations between asset classes, it seems that what you describe is becoming mainstream thinking.

Another example (skip the section on China, look at graph Cyclically Adjusted Earnings Yield US 10yr Bond Yields... and associated commentary):

http://archive.is/6BCMF

 

I wish I could see what's coming but it is always darkest just before the Day dawneth.

 

[vinod1]

 

Buffett has said many times that he does not feel the stock market is expensive when the US 10 year treasury was yielding In the low 2% range. I wonder what he will say when the 10 years is yielding 3 or 3.5%?

 

 

I have been very closely following Buffett's comments on interest rate impact on stock valuations. Buffett has said that stocks would look cheap in three years time if interest rates were 1% higher, but not if they were 3% points higher. I think he made these comments when the 10 year is in the 2.2% to 2.3% range.

 

I think only if bonds start hitting the 4% range it would start impacting stock valuations.

 

Vinod

[EliG]

Gundlach also called for the S&P to finish the year down in 2018 (which is quite the gutsy call given everything that has happened the past 14 months): after a strong start, as the 10 year moves close to 3.00% he expects stocks to sell off later in the year as higher bond yields (and the threat of even higher bond yields in 2019) eventually starts to factor into stock market valuations.

 

When yields are below 5%, rising rates have historically been associated with rising stock prices.

 

See attached chart from JPM Guide to the Markets.

[Guest cherzeca]

@eliG

 

so from graph (thanks for posting) it appears that since 1963, whenever 10yr treas rate was below 4%, there never was a two year month to month comparison to stocks where rates went up and stocks went down...which is pretty remarkable.

 

but given the history of interest rates since 1963, aren't we only considering for this subgroup of rising rates < 4% a historical period back in the 60s, certainly before reagan and i would venture without looking before carter?

 

since reagan we have been almost entirely in a lowering interest rate environment.  just wonder how relevant to current situation

[rb]

Here's whats bothering me about the slide that EliG posted:

 

Over the period of the chart: May 1963-Dec 2017 10 year treasury has been below 4% in the following periods:

 

May 1963-Jun 1963

Sep 2002-Jul 2003

Jun 2005-Jul 2005

Jan 2008-Present

 

Basically the long period of time is meaningless. All the data in there is recent history which we're all familiar with. Including one month from 1963 is statistically meaningless. Also May 1963 feels like a weird cutoff point for a dataset.

 

[EliG]

since reagan we have been almost entirely in a lowering interest rate environment.  just wonder how relevant to current situation

 

JMP chart looks at the weekly stocks returns. I think it captures every little zig and zag in the 10 year treasury rate. There were quite a few of them since year 2000. See the chart below.

 

That said, I agree with the skepticism that you and rb expressed.

[Viking]

Moving forward, I think the ECB and BOJ will be key to long bond yields.

 

It really has surprised me what the FED has been able to accomplish in the US in the past 15 months. The Fed has demonstrated over the past 15 months that a central bank can raise rates from crazy low levels with little impact on the overall economy; they just need the guts to do it :-). I think back to pre-Sept 2016 and for 8 years straight all everyone was talking about all day was what the Fed was going to do. Today they are way down on the list of topics (and still important).

 

The ECB and BOJ have to tighten at some point in time so when the next recession comes they have options. They have a window today to do so. IF they do start to shift their stance I think bonds on the long end could spike (with a quick move of 40 or 50 basis points) and this could certainly spook stock markets.

 

I think the number one risk to the stock market today is a rapid rise in 10 and 30 year bonds. But this will only happen if the ECB and BOJ shift and get much more aggressive with slowing bond purchases and hiking rates; may happen in 2H if global economies continue to show solid growth.

[vinod1]

I am attaching a chart of 10 year treasury rate from 1790 onwards. Data from 1871 onwards is more reliable but this is the data we have.

 

1790 to 1870 rates are 5% to 7%

1870 to 1960 rates hovered around 3%

1960 to 2000 rates shot up from 5% to 15% and then back to 5%

2000 to 2017 rates kept dropping from 5% to 2%

 

When people talk about "Normal" they are primarily referring to the 1960 to 2000 period.

 

When people talk about "New Normal" they are primarily referring to the post 2000 period.

 

But what is normal, is really a matter of how far back you are looking.

 

If we consider rates from 1870 ("Old Normal"), then current rates are nothing unusual.

 

If we consider rates from 1790 ("Really Old Normal"), then current rates are indeed low but not exceptionally so.

 

Vinod

[Guest cherzeca]

so the thought provoking idea in this thread is, if you believe that rates go up in 2018, is that good or bad for equity.  gundlach says bad.  historical evidence is equivocal though the JPM graph implies that it's good at least until 10 yr hits around 5...which is almost double from here.

 

 

[rb]

I would say it's bad. That's because there's only one scenario in which that's good. That is that the fed raises rates to counteract an overheating economy. In that overheating economy corporate earnings surprise on the upside to overcome the increased hurdle rate. I don't think the odd of this are great.

 

Then there is a plethora of other scenarios, all of them bad. So while I can't predict the future I'm going with higher rates not good.

[Packer16]

But what is going to drive rates higher?  The only thing that drives rates higher for longer is inflation.  What drives inflation? Shortages of either people or materials.  I do not see either & just more capital being created with little destroyed which would cause shortages.  The interesting thing is that although the 10-yr rate has risen the 20-yr rate has been flat.  So we have a flattening of the curve versus a shift upward which tells me that Fed policy is bucking what the market wants to do.

 

Packer

[TwoCitiesCapital]

But what is going to drive rates higher?  The only thing that drives rates higher for longer is inflation.  What drives inflation? Shortages of either people or materials.  I do not see either & just more capital being created with little destroyed which would cause shortages.  The interesting thing is that although the 10-yr rate has risen the 20-yr rate has been flat.  So we have a flattening of the curve versus a shift upward which tells me that Fed policy is bucking what the market wants to do.

 

Packer

 

I tend to agree with this. Demographics support lower rates than would be expected in a similar scenario for the ENTIRE developed world. Further, pensions are dramatically underfunded and have been waiting 10+ years for higher rates that EVERYONE expected to come - at this point, many of them are desperate and dump billions into the marketplace to buy duration the moment rates back up 50 basis points. These are literally the whales in the market place - it pays to pay attention to their motives.

 

With demographics supporting the move into fixed income, forced buyers like pension plans in the mix, and central banks just waiting to buy at the hint of the next downturn - it's hard for me to envision long-term rates (10-years and onwards) getting much above 3% before the next rally in yields starts - particularly IF/WHEN the next hint of economic weakness comes through. T

 

he bond bull market WILL end - I just have a hard time envisioning it's immediate demise in a global environment that reflects demographic demand, low inflation, and desperate buyers with A LOT of money (pensions and Central Banks).

 

I'd revise this theory if inflation were to consistently exceed 2-2.5%. At that point, pensions might delay duration binges a bit in anticipation of higher rates and Central Banks would likely have the confidence to continue hiking which might exceed the drag from any demographic demand. Until then, I'm still in the camp of rates will head lower and this is merely a bounce within the secular trend downward.

 

I have all the respect in the world for Gundlach, but he has been wrong before about the bottom being in for rates and I imagine he may be wrong again. Crazy how some of these fund managers ignore the motives\movements of their largest clients (pensions).

[John Hjorth]

Moving forward, I think the ECB and BOJ will be key to long bond yields.

 

It really has surprised me what the FED has been able to accomplish in the US in the past 15 months. The Fed has demonstrated over the past 15 months that a central bank can raise rates from crazy low levels with little impact on the overall economy; they just need the guts to do it :-). I think back to pre-Sept 2016 and for 8 years straight all everyone was talking about all day was what the Fed was going to do. Today they are way down on the list of topics (and still important).

 

The ECB and BOJ have to tighten at some point in time so when the next recession comes they have options. They have a window today to do so. IF they do start to shift their stance I think bonds on the long end could spike (with a quick move of 40 or 50 basis points) and this could certainly spook stock markets.

 

I think the number one risk to the stock market today is a rapid rise in 10 and 30 year bonds. But this will only happen if the ECB and BOJ shift and get much more aggressive with slowing bond purchases and hiking rates; may happen in 2H if global economies continue to show solid growth.

 

I'm the least of a macro person one can think of, however I'll try to pursue Vikings post here a bit, on a more specific level.

 

I have several times posted here on CoBF, that with regard to Europe, I think one need to see and understand the shades and nuances of the economic development in Europe/EU. It's not just "a mess" in general. That, however, does not imply that there aren't problems, because there are.

 

European Commision: Autumn 2017 Economic Forecast.

 

If you really try to work with that page by clicking around on the map way down on that particular page and read just parts of the data contained in the map [click on the country you need data for] and the documents attached for each country, there is actually a ton of information and data about the reasonable current European economic situation.

 

Some observations:

 

1. The Scandinavian countries are doing fairly well.

2. Several of the Eastern European countries actually have strong growth right now.

3. The economic situation has materially changed in Spain and Portugal to the better, compared to a couple of years ago - the pendulum is on its swing on the right trajectory.

4. Even Greece is in growth mode now.

 

Over the last two years or so, the picture has changed from being "South [in general] is a mess" to that we now have an axis NW-SE orientation through Europe as an indicator of weakness: UK, France & Italy.

 

No need here to elaborate on UK, I haven't studied the French situation either yet, and then we have Italy: Italy hasen't really fixed its banks yet, so they are [in general] not able to support a ramp up of growth by lending.

 

I speculate, that's the real problem here for ECB, and I speculate that is the direction ECB is looking nervously - trying not to push Italy back in the hole again. [Like contrary to FED looking at the here on CoBF well covered Detroit economic situation to set interest rates.]

[Cigarbutt]

Just thinking out loud and not taking a specific position on the role of the ECB.

The 2017 report is interesting and draws a realistic picture of the present situation. Thanks for the link and the observations.

 

Just re-read their 2006 and 2007 Economic Forecasts.

 

Definitions

Forecast: prediction based on objective facts (ideally) or experience or something else. (my bold)

Foresight: vision, or a horizon of expectations, based essentially on your internal farsightedness, prudence or general mental preparedness. (my bold)

 

I would venture to say that if macro is useful at all, it should rest (at least try to) on the latter definition.

 

With all due respect, I find that the ECB does not discount the possibility that what "it" thinks or does may not be relevant for the Markets in certain scenarios. :)

[John Hjorth]

... With all due respect, I find that the ECB does not discount the possibility that what "it" thinks or does may not be relevant for the Markets in certain scenarios. :)

 

I like this line of thinking, Cigarbutt, [ : - ) ]

 

So what we really are looking for is an independent observer of this game, that is very smart and possesses foresight [in your terminology]  and willing to engage in forecasting. [in the context, that we know that the smart persons with such properties don't really engage in such activity] [: - ) ]

 

Point taken with regard to ECB. It's actually important here. It's a decisionmaker's description & view on the situation.

[HJ]

But what is going to drive rates higher?  The only thing that drives rates higher for longer is inflation. 

Packer

 

This may have been an easy statement to make when main players in the treasury market are private entities, banks and insurance companies, foreign or domestic.  Today, half of the treasury market is owned by foreign central banks and Federal Reserve, whose motivations are driven by as much politics as economics.  This statement becomes more questionable.  Over the long term, it certainly remains true.  But that long term can be much longer than most people's investment horizon. 

[Viking]

Long bond yields are continuing higher. The question is not if yields continue to move higher; I think higher yields is understood and accepted by financial markets. The question is rather how fast they will rise and at what level will the stock market start to pay attention.

 

What is the real driver of higher yields? I do not think fears of inflation is the driver. Rather, I think there is finally a realization that central banks around the world are currently far too accomodative with policy. The economies in the US, Europe and Japan have reached a stage where central banks need to normalize policy. And financial markets and economies appear to be ok with higher rates. The Fed gets it and is normalizing policy quickly. I think the ECB is just starting to get it.

 

I am sure something very significant is happening in the bond market; just not sure how it all plays out. In late December of 2018 when we look back on the year I think this may be the surprise story of the year. The move in yields the past 16 months has been pretty dramatic. We will see what the next 11 months have in store. Very interesting :-)

 

                      Sept 27 2016.    Jan 1 2018.    Jan 31 2018

US 2 Year.        0.75                      1.92.          2.14

US 10 Year.      1.56                      2.46            2.72

US 30 Year      2.28.                      2.81.          2.95

 

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

[petec]

I am attaching a chart of 10 year treasury rate from 1790 onwards. Data from 1871 onwards is more reliable but this is the data we have.

 

1790 to 1870 rates are 5% to 7%

1870 to 1960 rates hovered around 3%

1960 to 2000 rates shot up from 5% to 15% and then back to 5%

2000 to 2017 rates kept dropping from 5% to 2%

 

When people talk about "Normal" they are primarily referring to the 1960 to 2000 period.

 

When people talk about "New Normal" they are primarily referring to the post 2000 period.

 

But what is normal, is really a matter of how far back you are looking.

 

If we consider rates from 1870 ("Old Normal"), then current rates are nothing unusual.

 

If we consider rates from 1790 ("Really Old Normal"), then current rates are indeed low but not exceptionally so.

 

Vinod

 

The US was (largely) on the gold standard from 1971. The idea of the gold standard was that your dollar maintained its purchasing power measured in gold. In the long run, productivity growth might be expected to be equal to or even greater than gold supply growth, so in theory you could expect the purchasing power of your dollar to hold or even rise. And that's exactly what happened - inflation was negative in cumulative terms from 1870 to 1913, for example, and was almost zero in cumulative terms from 1870 to 1939 despite the devaluation of the dollar vs. gold in the 1930s. (NB I pick the starting date of 1870 because that's the first date Schiller has data for on his downloadable CAPE spreadsheet, and I pick the dates 1913 and 1939 as the last "normal" dates before major wars, which are always inflationary. I realise the deflationary decade leading up to 1939 was not normal, but nor was the inflationary decade leading up to 1929, and under the gold standard inflation and deflation had to more or less even out over time.)

 

Inflation became a feature of life from 1939 onwards (a function of the 1930s devaluation, war, credit creation in the postwar boom, and guns 'n butter policies) putting so much pressure on the gold standard that the US finally gave up on it in 1971 (the alternative would probably have been another depression). So, since 1971 we have had purely paper money. That brings the risk of inflation - and in fact, inflation has become an explicit policy target.

 

My point is: that change in inflationary expectations should have a significant impact on nominal rates, so you can't compare today's rates to those pre-1970 and certainly not to those pre-1940. A 3% rate under the gold standard was more or less 3% real with a very small risk of loss. 3% today is 1% real if the Fed hits its target and carries a real risk of loss if the Fed loses control for a period.

 

P

[mattee2264]

 

  I think a lot of people assumed the impact of quantitative easing would be inflation. Well it was. But inflation in financial assets rather than real assets. Presumably there will come a point where wealth effects drive consumption (although I think a lot of the beneficiaries are the very rich who have a low marginal propensity to consume) and also a point where companies start believing returns are better from capital investment than financial investment. Also it is usual at this stage of the cycle for commodity prices and wage inflation to start to push up prices and that hasn't really been a feature. Although you would think that could change. And as was pointed out it is not the appearance of inflation but the anticipation of inflation that will set things off. I think a lot of actors out there are suffering from a money illusion believing in the death of inflation which makes sub 3% nominal bond yields and 4% stock earning yields (adding maybe 2% for autonomous growth) seem reasonable. But over any medium term holding period you would expect inflation to eventually eat into those returns.

 

[petec]

 

  I think a lot of people assumed the impact of quantitative easing would be inflation. Well it was. But inflation in financial assets rather than real assets. Presumably there will come a point where wealth effects drive consumption

 

Or a point where markets fall and people realise they were only wealthy on paper ;)

 

Strikes me the best case outlook from here is for tight employment markets, rising wages, rising demand (because finally money goes to those with a high propensity to consume), and thus rising capital investment. That could lead to higher real GDP growth (and might or might not lead to inflation depending on credit creation). But it strikes me it could also lead to lower corporate margins.

 

Or the whole thing could crash tomorrow ;)

 

[Cigarbutt]

Interesting topic.

So many variables, including sentiment.

Not clear though how this can "impact" investment decisions/outcomes.

Maybe should spend the time reviewing DaVita instead.

The theme is to assess the possibility of "restructuring" and how to position to have protection or to benefit.

 

Trying to connect some dots after reading an interesting report that is relevant to the US government 10 year bond yield.

http://en.dagongcredit.com/index.php?m=content&c=index&a=show&catid=88&id=4937

 

The complete report (bottom of page) has some nice graphs. I understand that the analysis may be biased but isn't it interesting to learn about competitors' assessment?

Especially if they are major owners of the very paper (electronic entry) they are holding?

 

So, can the US government default?

The answer is very likely no in the classic sense given the ability to "print" its own currency and given our present risk-free environment.

But the default definition can be elastic.

 

Interestingly, in January 2009, Mr. Market (the credit default swap spread market) assigned a probability of US government default at 6% (!) over the next 10 years. (Amazed by this phenomenon as one had to rely on a counter-party  ???)

Since then, I understand that the measure has remained below 1%, and often a small fraction of 1%.

 

end 2008:    total public debt/GDP=73,5%

Q3  2017:    total public debt/GDP=103,8%

 

The US has never failed to repay its debt. But there were two episodes where the elastic definition applied. First in 1790 (interest deferral in a venture capital spirit) and in 1933 with the gold devaluation that petec referred to.

 

At this point with the economy firing on all cylinders, the public deficit stands at about 3,5% of GDP (growing trend) and private savings rate (December 2017) is at 2,4% (low point and declining).

 

More questions than answers at this point.

 

In 2018,

-What is the standard of value?

-What is the (real) price of debt?

-If you represent the standard of value and you need somehow to devalue, how can you devalue without "partners" doing the same?

 

One can hope that the underlying economy can reach its full potential.

 

Interesting times for the 10 Year Bond.

 

 

[Viking]

Bond yields spike and stocks... do nothing. WOW. Volatility looks like it is coming back.

 

                      Sept 27 2016.    Jan 1 2018.    Jan 31 2018.    Feb 1 2018

US 2 Year.        0.75                      1.92.          2.14.                2.16

US 10 Year.      1.56                      2.46            2.72.                2.78

US 30 Year      2.28.                      2.81.          2.95.                3.01

 

Gundlach said 3% was the critical level for the 30 year; he said once the 30 year passed 3% you can officially put a pitchfork in the bond bull market and call its end. We will see how fast yields continue ie to move higher. Currently the experts are calling for the 10 year to hit 3% by the end of the year... looks to me like 3% will be taken out by the end of March.

[JayGatsby]

But what is going to drive rates higher?  The only thing that drives rates higher for longer is inflation. 

Packer

 

This may have been an easy statement to make when main players in the treasury market are private entities, banks and insurance companies, foreign or domestic.  Today, half of the treasury market is owned by foreign central banks and Federal Reserve, whose motivations are driven by as much politics as economics.  This statement becomes more questionable.  Over the long term, it certainly remains true.  But that long term can be much longer than most people's investment horizon.

Even putting politics aside, it seems like it's still supply/demand. As supply of t-bills goes up there has to be equal demand for rates to stay the same. Otherwise rates have to increase to stimulate demand. Foreign governments have a choice of investing in the US (via t-bills) or investing in their own countries.

 

Like with companies, being dependent on outside financing seems risky because you're tied to the whims of those investors. T-bills are a complicated market though, that I'm far from an expert in. We'll see.

[Spekulatius]

Higher LT interest rates, unless they are offset by higher growth rates, should put pressure on the valuation of a lot of asset classes, most importantly residential and commercial real estate. I know many like banks as a ply on higher interest rates and while it is true that they would benefit from higher NIM, the region banks loan portfolio are chuck full with  commercial RE loans. Now add disruption in retail to this equation and I can see some real potential for nasty writeoffs for non performing loans in this sector.

 

Reits are potentially going to be hit by a double whammy of lower asset valuation no higher financing costs, maybe even a triple whammy when they are in retail RE.