At the beginning of the year, the yield on 10-Year U.S. Treasuries was just shy of 3% and appeared ready for takeoff into the stratosphere. Alas, the long-awaited period of runaway interest rates had arrived!
The something weird happened. U.S. Treasury yields (ChicagoOptions:^TNX)– like a schizophrenic mad scientist straight out of the movies – suddenly reversed course and have since fallen around 14%. (Lower yields equal less income for bond investors, more on that later.) Is this an isolated trend?
Actually, the “Great Yield Slide” is happening globally (BWX).
Italy and Spain – countries that were recently on the brink of defaulting on their debt – have experienced sliding yields too and now pay just 6 to 18 basis points higher versus similar maturing 10-year U.S. debt (IEF). What’s good for borrowers isn’t necessarily good for creditors, said nobody.
Does the current cycle of depressed bond yields still have legs?
For whatever its worth, the International Monetary Fund (IMF) gave its latest outlook of the U.S. economy and how zero percent short-term interest rates could persist even longer than the Federal Reserve is projecting.
The IMF states:
“The Fed currently has to contend with multiple areas of uncertainty: the degree of slack remaining in U.S. labor markets; the extent to which this slack will translate into future wage and price inflation; and the transmission to the real economy of a future move upwards in policy rates. These substantive ambiguities make the outlook for U.S. monetary policy particularly uncertain, as the Fed has repeatedly communicated. At the same time, longer-term treasury yields and the term premia have been compressed to very low levels. Under the staff’s baseline, the economy is expected to reach full employment only by end-2017 and inflationary pressures are expected to remain muted. If true, policy rates could afford to stay at zero for longer than the mid-2015 date currently foreseen by markets.”
What do persistently low rates or yields mean?
From the fixed income or bond investor’s perspective (TLT), the decrease in bond yields has been offset by a corresponding rise in bond prices. (See chart above) This might seem like a blessing in disguise, but it really isn’t. That’s because fixed income investors aren’t buying bonds (BOND) for capital gains – they want income!
If we use the 31% fall in 10-Year U.S. Treasury yields over the past five years as a gauge, it serves as a rough approximation of the 30% income blow that bond investors have taken.
A continuation of low interest rates – beyond the Fed’s arbitrary timeline for rate hikes – will happen quietly and catch many by surprise. It will also bash income investors (like all the times before) who use conventional income and dividend strategies during these unconventional times.
On the other hand, persistently low rates is an ideal environment for two industry sectors which are are up more than 38% over the past three-years and were recently featured in ETFguide’s Weekly ETF Picks. Not that it matters, but both sectors also carry dividend yields above 10-year Treasuries and 85% higher versus the S&P 500.
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