Government bond yields recently held over a significant level, but another test may prove harmful for the stock exchange.
The benchmark 10-year Treasury note yield analyzed 1.5percent in late August and early September, bouncing off that amount and most recently trading around 1.8%.
That is the next time the barrier was broken because the economic recovery started in mid-2009, with the return bouncing up powerful every time. This indicated that the renewal of the longest bull market run in Wall Street history which has coincided with the most durable growth in U.S. history.
However, another challenge could mean tough times on the horizon, according to an analysis by Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch. In his weekly analysis of market flows, Hartnett called the 10-year’s moves over the last ten years, and especially its ability to keep above the 1.5% yield level, “the most important chart in the world.”
Hartnett explained that the stock exchange has maintained a close connection with bond yields which could become ominous if fixed income phases another major rally, which he expects to occur in 2020 and become a drag on shares and other risk assets.
“For the past 10 years, the correct market mantra has been lower yields mean lower credit spreads and higher stocks, so long as lower yields prevent recession. But given 1.5% on the 10-year Treasury was not breached in 2012 & 2016 when recession fears were high, a break below in 2019 would incite fears of a recession ‘tipping point’ causing higher spreads and lower stocks,” he explained in an email.
Truly, recession fears were raised during much summer time, cresting when the two-year return briefly passed over the 10-year, a phenomenon called an inverted yield curve. Inversions have been dependable recession indicators for the past 50 years.
but a swell of mostly positive economic information , revived hopes for a trade deal between the U.S. and China and the long-awaited statement of more monetary stimulus from the European Central Bank helped turn the tide for bond returns, finishing the 2-year/10-year inversion and signaling that things might not be as bad as feared.
Investors have been fleeing bond funds because yields bottomed earlier this month, with $6.1 billion in outflows over the previous week, the second-biggest streak of redemptions on record, according to BofAML data. The move came as the 1.5% level held, which coincided with a boost in opinion.
“Emotionally and psychologically it probably was big because of the fact that global yields are negative. If we did break to a new low in that 10-year that we haven’t seen, that could have set off talk about breaking 1%,” said Jim Paulsen, chief investment strategist in the Leuthold Group. “That could have been very risky given the fragile state of where mindsets are now with recession, and that might be just enough to freeze up the financial markets.”
But, while the BofAML plan team is favorable for risk assets in 2019, it’s bearish beyond that as it anticipates returns to return lower. Hartnett stated in his note to clients he sees a 2020 using a “bond bubble pop” which”induces [a] Big Top in charge (spreads trough) & equities (multiples summit ), causing Wall St deleveraging & Main St recession.”
“There’s a good chance that U.S. rates are going to sell off, said Robert Tipp, chief investment strategist at PGIM Fixed Income. “Our prices are just unsustainably high vs. the rest of the world.”