Treasury yields continued to fall Thursday amid strong demand for U.S. government debt despite growing stagflation fears — suggesting investors in the $23 trillion government bond market are giving up on trying to forecast the long-term outlook.
That’s the view of Deutsche Bank Securities research analyst Aleksandar Kocic. In a phone interview Thursday, Kocic said Treasury investors “are not pricing in the possibility at all of stagflation, in which both stocks and bonds would sell off.” Otherwise, long-end yields would be much higher than where they are, he said.
To be sure, stocks and bonds have sold off in tandem for much of this year on expectations of higher rates and inflation fears — leaving all three major U.S. stock indexes nursing double-digit declines and the bond market in one of its worst shapes since the Civil War. The painful selloff of Treasurys has driven the benchmark 10-year rate up by 118.7 basis points as of Thursday from where it was on Jan. 3, according to Dow Jones Market Data.
Stock investors remain preoccupied with the notion that the U.S. might be heading into a period of higher inflation and interest rates, along with slower growth. Dow industrials DJIA just had their biggest six-day decline since March 23, 2020, while the S&P 500 SPX moved closer to bear-market territory on Thursday.
By contrast, the bond market appears to be taking a breather from stagflation worries this week. And that’s especially noteworthy given the crucial role that the Treasurys sector plays in capital markets, by sending out signals about the long-term outlooks for inflation and the economy.
Theoretically, bonds ought to still be selling off alongside stocks right now because stagflation fears usually trigger selloffs in just about everything — from equities and fixed income to credit and currencies. And whenever investors sell off bonds, yields jump higher.
Instead, long-end yields keep falling, driven largely by demand from investors with risk parity portfolios seeking to offset underperforming stocks by buying bonds, Kocic said.
The 30-year rate BX:TMUBMUSD30Y, at just below 3% on Thursday, is still too low relative to where the 10- BX:TMUBMUSD10Y and 5-year rates BX:TMUBMUSD05Y sit, he said. The 10-year was around 2.82% as of Thursday, after briefly spiking above 3.2% on Monday.
The bond market is “abdicating on its attempt to forecast anything” beyond the short term, and “leaving the back end alone and not doing any trade that reflects long-term views,” Kocic said. “All it sees is a stock market that’s causing rebellion.”
“The main risk is that the market doesn’t really have a handle on inflation anymore, and it’s not quite clear that Fed rate hikes will do the job,” he said. “The idea being that the Fed will hike, but it might not be enough to tame inflation while, at the same time, adversely impacting growth. Monetary policy would be impotent in that case.”
Deutsche Bank AG DB was the first Wall Street bank to call a U.S. recession during the current elevated-inflation era, and has acknowledged the prospect of downside risks to its own forecast. It sits on the more pessimistic end of the spectrum among professional forecasters.