the weirdness of interest rates

The 10-year US Treasury note has traded at the following yields so far this year:

1/1/21 0.93%

2/1/21 1.09%

3/1/21 1.45%

3/19/21 1.74%

3/31/21 1.74%

4/1/21 1.69%

5/1/21 1.63%

6/1/21 1.62%

7/1/21 1.48%

yesterday 1.29%.

The two mid-/late-month quotes in March mark the height of the runaway inflation fear that gripped the market earlier in the year. The subsequent movement of Treasury yields illustrates how far away we’ve come over the past month or two from the near-hysteria of late winter.

Still, the essential issue in today’s bond market remains unaddressed by investors. If we think that the long-term level of inflation is a 2% yearly rise in overall prices, current Treasuries are providing no real return to holders. In fact, the 10-year pencils in a 70bp annual real loss from holding them to maturity. So why should Treasury yields be falling, i.e., why should Treasury prices be rising?

Could this be the least-bad choice for investors? If we’re talking about mutual fund or pension fund managers who have specific instructions that limit their ability to stray from long-dated high-quality fixed income, maybe so. For you and me, however, probably not.

Nor is there any evidence I can see that the overall economy is about to enter recession. Yes, we’re seeing the first signs that the shortages of just about anything one might want to buy are beginning to ease. But I’d argue that’s a good thing–and a reason to run to stocks rather than flee to Treasuries.

Two possibilities that I see:

–technical buying, meaning large investors mistakenly betting heavily, on margin, that Treasury prices would continue their March swoon and now being forced to unwind their short positions by repurchasing the bonds they’d previously sold

–foreign buying. In a non-US world of zero or negative nominal yields, 1.3% might actually be a good deal. To the extent that the Biden presidency is defusing the idea that today’s US is following the path of 1930s Germany, thereby diminishing the capital flight trade, foreigners might anticipate the additional plus of a currency gain.

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