What does the US Treasury yield slide tell us?

June 14, 2019 10:19
A sharp drop in 10-year US government bond yield suggests, among other things, that market participants are betting on a fresh round of quantitative easing from the Fed. Photo: Reuters

US Treasury yields have fallen sharply in recent months, which is a rare scenario in recent years.

The 10-year US government bond yield has slumped to a low of 2.1 percent early this month, the lowest level in nearly 21 months, compared with a peak of above 3.2 percent at the end of last year. It marks a decline of 117 basis points. Two catalysts behind the substantial fall are rising safe-haven demand and the Fed’s policy shift.

Various equity markets have been falling since April, especially emerging markets. The financial markets have become increasingly volatile due to uncertainties surrounding the US-China trade talks.

In fact, the VIX/VXV ratio has hovered at a high level over past six months or so. The VIX is a real-time market index that represents the market’s expectation of 30-day forward-looking volatility of the S&P 500, while VXV measures volatility over a 3-month basis. It shows investors are more worried about short-term volatility in US markets, and they are pulling money out of stocks and fleeing into US Treasuries.

Meanwhile, the latest federal funds futures are reflecting a 97.5 percent chance of a rate cut by Fed before the end of this year.

The sharp bond yield drop also indicates market participants seem to be betting on a fresh round of quantitative easing.

Previously, long-term Treasury bond typically went through a notable decline before a QE move from the Fed. Such fall usually amounts to 100 basis points or more.

As the 10-year bond yield has already slumped by 117 basis points from the peak, this seems to be in line with the historical pattern.

The full article appeared in the Hong Kong Economic Journal on June 13

Translation by Julie Zhu

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Hong Kong Economic Journal chief economist and strategist