“One reason that rates have not moved higher could be that the markets are not convinced of the sustainability of economic growth,” he says. Another reason may be the growing concern over the crisis in the European Union and the spill-over effects that may have in the U.S., he adds.
Not surprisingly, given the safe haven status of Treasuries, rates across the curve had moved sharply lower with the yield on the 10-year Treasury note. While the 10-year has bounced from record low levels, “Nothing precludes it from moving lower in the near-term, especially if the situation in Europe worsens,” Lusk says.
“The argument going forward will be the trend remains your friend for both the 10- and 30-year, with the 10-year hitting below 1.50% if more stress arrives from the European debt crisis. If we do see greater contagion risk from Greece and Spain, the [European Central Bank] and ultimately the Fed will come in with supportive policy stances to combat the crisis,” he says.
Garner says that Treasury bulls also have grown overly comfortable knowing the Fed essentially is offering a put option on bond prices. Likewise, the bears have not fared well and have become hesitant to place bets against the Fed by shorting bonds and notes. This has been displayed by the market’s tendency to rally on chatter or expectations of more quantitative easing measures, but to soften as the actual programs are implemented.
Derek Holt, an analyst with Scotiabank, says that lower Treasury yields are not the motivation of the Fed in any consideration of additional asset purchases and that market inflation expectations, stocks and corporate bond spreads provide justification for further quantitative easing (see “Treasury stimulus arguments,” below). “The Fed judged higher Treasury yields following QE efforts as a policy success,” he notes.
“If these trends push even further, as we think they will, the Fed could argue that additional stimulus should be designed to ward off fatter tail downside risks to inflation, either in the form of a too-sharp pace of disinflation or a return to outright deflation risk itself,” Holt says.
Investor psychology going forward will be precarious at best as apprehension and fear have ramped up during recent weeks, Lusk says. The yield curve has flattened, while the dynamics at the front-end do not appear set to change in the near-term, and the intermediate portion of the curve experiences increases expectations of further Fed easing.