Really? We hear it all the time..."Interest rates (government bonds) have nowhere to go but up". I remember hearing it from less-informed colleagues in 2009 and 2010, Investment Advisors since 2011. Not many have been bullish on yields going lower.
What is really interesting the past 6-9 months is that 10yr US treasury yields have largely peaked out at 2.60% in Dec/16, then again in Mar/17 and now look to be breaking down to post-election lows at 2.14%.
And the most interesting part is...the Federal Reserve Board (the US central bank) has raised rates two times (.25% or 25 basis points) since the election (Dec and Mar) and still look set to raise them again in June by 25bps and maybe even Sept or Dec.
And if it isn't enough that long bonds are moving to lower yields with the Fed raising short rates, the Fed is also talking about shrinking their balance sheet (filled with government bonds and government insured mortgages) later this year from the $4.5 trillion it currently stands at today compared to the $800 billion it was at pre-crisis in 2008. Conventional thought would have it that if the Fed stops buying government bonds, clearly bond yields would rise...not so fast.
Here is the chart of US 10yr Treasury bonds in yellow and the upper band of the Fed Funds rate (the rate the Fed lends overnight money to the major banks at) in white and the horizontal red line is the day after the election when US 10yr Treasury bonds were at about 1.90% vs today at 2.15%:
So what gives? Why are 10yr bond yields moving decisively lower (remember, bond yields and prices move in the opposite direction so lower yields mean bond prices are moving higher) if "interest rates" are moving higher and the Fed may start to shrink it's balance sheet?
First thing is to determine which "interest rates" are moving higher. Clearly, right now, it is only very short term interest rates, like the overnight Fed Funds rate, that are moving higher. The "yield curve" is a very complicated beast that extends out to 30yr yields, which are called the "long end" or the "back end" of the yield curve. As we can see from the chart above, the 10yr yield has been "rallying" or moving lower certainly since March. Why?
The answer to that question is two fold, but the answers merge with each other:
And what conclusion do we make from long bond yields dropping in the face of the Fed raising the Fed Funds o/n rate?
Given the massive short covering that has gone on the past few months, we will have to see if the fundamentals play out (no inflation and a policy error being made by the Fed) or it the move to lower yields was all just a short covering rally. I think the former combination, to be honest.
Either way, High Rock accounts will maintain a position in longer bonds as a natural hedge to the other risk assets (stocks) in our portfolio.