During the past few months, we have the treasury yield at a high of 1.75% around of the start of April and subsequently moved down to the current level of 1.28%.
Even with the ongoing concerns on inflation, the yield on the 10-years treasuries tells a different story. If inflation “is a concern”, the yield should have risen instead of falling.
I started to question who is buying the treasuries keeping the yield low and what is/ are the reasons for the buying. I have come up with a few possible reasons.
1. FED purchasing – with its $80 billion treasuries purchases likely to persist through the year, this would most probably put a downward pressure on the treasuries yield.
2. Ample liquidity – With global central banks pushing out fiscal stimulus since the start of the covid, the market has been flooded with ample liquidity, searching and hunting down yields. The whole world is running out of sovereign bonds to buy, especially sovereign bonds issued by a reserve currency-issuing country that carry meaningful interest rate return. This has created a demand for the 10-years treasuries and thus, depressing yields.
3. Short Coverings – just a couple of months back, the market was rocked by growing inflation concerns. Many institutions may have anticipated a tapering of QE and eventually, FED to raise interest rates. These institutions may have anticipated and shorted longer dated bonds and after the last FOMC, in which the FED has indicated that they are “just talking about talking about” tapering, started to cover their short positions pushing down the yields.
So what does all these mean?
Simply, the current yield of the 10-years treasuries is “manipulated” and not a clear indication of what it should be.
That said, JP Morgan has urged clients to not read too much into the recent bond rally.
FED has wanted to keep the borrowing rates down to ensure economic growth and stimulate employment, which is their current concern. As such, if the market is pricing in this “false” rates, there appears to be opportunities for investors to leverage on.
Banks and financial stocks have been sold down heavily in the past few weeks as a result of a falling yield, as profitability will be negatively affected with diminishing net interest margin. But if this current yield of 1.28% is a “manipulated” one, and we see yield rising going into the 2nd half of 2021, it may be a good idea to position into them. Moreover, at the recent stress tests, all banks passed it with flying colours and was allowed to continue share buybacks and resume dividends payout.
Immediately after, various banks started to announced increasing dividend payouts and share buyback programs. This reflects the financial strength of these major US banks.
I would personally take this as an opportunity to load up and overlook the volatility. Moreover, this volatility was expected before the start of the 3rd quarter. I have talked about a possible bull market correction here. I have also talked about a volatile market expected starting 3rd week of June through to October here. I have also written about the flattening of the yield curve here.