What are Lower Yields Telling Us?
On March 19, 2021, the benchmark ten-year US Treasury bond closed yielding 1.74%. By the first trading day in August the bond’s yield had dropped to 1.20%. With all of headlines and talk about rising inflation, why have bond yields dropped so significantly since March?
The bond market and stock market are commonly known as leading indicators for the economy. In fact, the S&P 500 and ten-year US Treasury spreads vs. Federal Funds rates are included in the Conference Board’s leading index.
However, the stock market and bond market sometimes give conflicting signals. When that happens, which one is right?
If you look at October 9, 2007 for clues, you’d conclude that the stock market had no idea what was about to begin in the next 60 days. On that day, and less than two months before the onset of the Great Recession, both the S&P 500 and the Dow Jones Industrial Average recorded new closing highs.
What about bonds as an indicator? More recently, US treasury bond yields are influenced by more than just inflation economic or concerns. Factors like near zero and in some countries negative government bond rates abroad make even a paltry 1.2% bond rate look attractive.
So, what exactly is the informational value in zero overnight rates and a declining ten-year treasury yield?
Slower Growth Ahead?
For starters, it may be signaling low inflation or even disinflation (inflation still rising but at a slower and slower pace). If the bond market was really concerned about inflation, longer bond yields ought to be significantly higher. Also, the Federal Reserve bank (the Fed) would not be leaving overnight rates at zero as they recently announced.
Another signal is the possibility of slower economic growth ahead. Over the past twelve months or so, the US Government has passed nearly to $6 trillion in new spending and various COVID relief bills. And the Fed has purchased treasury bonds, corporate bonds, and even lower grade corporate bonds in an effort to support companies impacted by COVID shut-downs.
Federal spending initiatives and monetary Fed backstops all have a limited life span, and that life span is gradually coming to an end. Even so, looking back at emergency fiscal and monetary programs during the Great Recession, some lasted years.
For instance, the Fed started the quantitative easing (QE) bond buying programs in 2008 and it was still buying bonds well into 2013. They also waited until December 2015 to raise overnight rates off zero.
Do Falling Yields Impact Investors?
What does this mean for investors? Most obviously, investors will earn lower income from bond holdings. Regarding stock holdings, investors may want to proceed with caution. Stock indices and many individual stocks are trading at historically high valuations. High valuations can be okay if growth rates remain high.
If the overall economy slows, it only stands to reason that corporate growth will slow with it. This may cause investors to re-evaluate stock valuations and re-price stocks to the new economic outlook. A good way to proceed is to keep your goals in sight, keep your investments aligned with your goals, and talk with your adviser about your specific situation. We’re glad to have a conversation, just give us a call or drop us a line.
This material is provided by Schmitt Wealth Advisers for informational purposes only. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. Opinions expressed by Schmitt Wealth Advisers are based on economic or market conditions at the time this material was written. Economies and markets fluctuate. Actual economic or market events may turn out differently than anticipated. Facts presented have been obtained from publicly available sources believed to be reliable. Schmitt Wealth Advisers, however, cannot guarantee the accuracy or completeness of such information. Past performance may not be indicative of future results.