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The U.S. 30-year Treasury bond yield dropped to an all-time low on Friday, sparking worries among investors who wonder what it’s saying about the economy’s future prospects.
Analysts say the slump in the long bond’s yield this week reflects a confluence of factors including easy Federal Reserve monetary policy, concerns about the COVID-19 epidemic’s impact on economic growth, and an absence of inflationary pressures.
Historically, a slump in long-term yields can indicate fears that growth will start to disappoint and inflation will fall which may make the real return on bonds more attractive.
On Friday the 30-year U.S. Treasury bond yield TMUBMUSD30Y, -2.34% fell 5.2 basis points to 1.92% based on Tradeweb data to an all-time low of 1.89%. The 10-year note yield also tumbled below the key level of 1.50%, last trading at 1.475%.
Here’s a few reasons why the bond-market made history on Friday.
Coronavirus worries
Heading into Friday investors were already on the watch for signs of the economy succumbing to the coronavirus epidemic amid fears that it would disrupt global supply chains and weigh on growth estimates for China which now has the second largest economy in the world.
See: COVID-19 tally: 76,767 cases, 2,247 deaths, 100 new cases in South Korea
So when IHS Markit released its weaker-than-expected U.S. February manufacturing and service sector purchasing managers surveys, the data sent panic among investors who received one of the first confirmations that the coronavirus impact could be more painful than thought.
With the exception of the U.S. government-shutdown of 2013, US business activity contracted for the first time since the 2008 global financial crisis in February, according to IHS Markit’s flash PMI data. Adjusted for seasonal factors, the Composite PMI Output Index (covering both manufacturing and services) slumped to 49.6 in February, down from 53.3 in the opening month of 2020. Weakness was primarily seen in the service sector, where the first drop in activity for four years was reported, but manufacturing production also ground almost to a halt due to a near-stalling of orders.
“Compared with official data, statistical analysis indicates that the survey indices are consistent with GDP growth slowing from just above 2% in January to a crawl of just 0.6% in February”, Chris Williamson, Chief Business Economist at IHS Markit, said.
The S&P 500 SPX, -0.87% index and Nasdaq Composite COMP, -1.42% deepened their losses following the PMI report as both benchmarks retreated from their respective record closes set earlier this week.
Read: Tech stocks lead Wall Street slide as coronavirus worries rise
As concerns around the coronavirus epidemic heat up, traders may also be looking to avoid holding short positions on long-dated Treasurys before the weekend, when further bad news on the coronavirus spread may be forthcoming.
“It’s hard to imagine any scenario where we get an ‘all clear’ on the COVID-19 front by Monday. But things can certainly get much worse in the next 60 hours. That asymmetry means its very hard to go into the weekend short safe haven assets,” said Jon Hill, an interest-rate strategist at BMO Capital Markets.
Central bank policy
Investors also turned to one of the usual suspects for the decline in long-term rates — easy central bank policy.
Though, members of the Federal Reserve’s rate-setting committee like Vice Chairman Richard Clarida say the central bank is unlikely to lower interest rates given the positive economic outlook and tight labor market, traders are betting otherwise.
The fed fund futures market is pricing in more than 40 basis points worth of cuts by the end of the year.
“There’s a lot of liquidity in the market, and we should expect even more stimulus from central banks,” said Marcelo Assalin, head of emerging markets debt at William Blair, in an interview.
He added expectations for stimulus from the U.S. had not only driven income-hungry investors into government bonds but also into the highest-yielding corners of fixed-income markets such as emerging markets.
Inflation expectations
Kathy Jones, chief fixed income strategist at Schwab Center for Financial Research sees the steady decline in inflation expectations as a key support for the rally in the 30-year bond also.
The 5-year, 5-year forward inflation expectation rate, which measures the expected inflation rate (on average) over the five-year period that begins five years from today, fell to 1.63% on Wednesday.
As economic growth worries take a toll on prices for industrial commodities and crude oil, forecasts for consumer prices to make a steady return to 2% have disappeared.
Fed officials have struggled to understand why inflation continues to shoot below their target even as unemployment rates have fallen and monetary policy has remained loose.
This persistent shortfall has led some researchers to suggest that inflation expectations are unanchored, and that the central bank’s efforts to meet its inflation objective was losing credibility, said Nathan Sheets, chief economist for PGIM Fixed Income.
