Roger J Kerr wonders whether the yields for US Treasury bonds are defying logic, and points to the non-economic drivers that may be behind the falls

 By Roger J Kerr

Contrary to my expectations, long term interests rates continue to move lower as US 10-year Treasury Bond yields defy economic logic and decreases to new lows of 2.28%.

Home mortgage borrowers in the US will be lapping up these unexpected decreases in interest rates, as will household borrowers in New Zealand.

The gap between our two year wholesale market swap rates and the 10 year swap rates has compressed up to just 0.44%.

The yield curve is unbelievably flat and the decision for all borrowers to fix for longer gets easier and easier. (Also see our video interview with Roger here where he discusses bonds, interest rates, monetary policy and currencies).

The drivers of lower US 10-year Treasury Bond yields at this time are largely non-economic and may be summarised as follows:-

- Geo-political tensions and crisis continue with the Islamic State insurgency in Iraq/Syria, Ebola virus and Russia/Ukraine.

- Two months ago investors were buying shares and buying bonds together. Today investor worries about global economic growth and higher US interest rates have sharemarkets reeling lower, however the bond buying continues as where else do you put your money? At some point a 2.28% interest income return on US bonds will not be sufficient reward with US inflation running above that level!

- Even at 2.28% US bonds offer a better yield than Euroland bond yields driven lower by deflation and the threat of another recession.

- The bond market has over-reacted to the Federal Reserve’s musings last week about some of the risks to US economic growth. A stronger US dollar exchange rate value is just not material to the overall US economy and US growth is unlikely to be compromised because of it.

At the end of the day, current holders of US Treasury Bonds (e.g. Chinese sovereign wealth funds and the Chinese Government) will now be closely examining their marked-to-market revaluation gains on their portfolios and cementing-in those gains in cash i.e. bond sellers from here.

The spectre of both bonds and equities being sold at the same time over coming months may not be that unusual, as we had both being bought together up until now. 

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Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com