US Treasury bond yields have crashed to record lows in 2011. Sovereign-debt worries in Europe, concerns about the slowing economy and the Federal Reserve’s commitment to low rates have all boosted demand for Treasuries, and thus depressed their yields.
Can Treasury yields really go any lower? Or should we be worried about a rapid bounce off current, historically low levels?
The answer depends very much on your time frame.
Near term, I believe that yields could fall even further. There are no viable alternatives to US Treasuries for those seeking risk-free (or “safe haven”) assets. Despite S&P’s downgrade, US Treasuries still reign supreme. This is particularly true since the Swiss National Bank said recently that it was aiming for a “substantial and sustained weakening” of the Swiss franc. In effect, the central bank eliminated the Swiss franc as an attractive alternative to the US dollar or US dollar-denominated debt.
Insurance companies and defined benefit pension plans also have a strong appetite for long-duration assets such as US Treasuries.
Finally, the Japanese experience over the past two decades demonstrates that when government debt levels get too high, deleveraging can lead to a long period of below-potential economic growth. These factors all argue for lower yields.
But two longer-term issues will eventually push bond yields up. First, unlike Japan, which has had low to negative nominal growth for the past decade or more, the US has had positive nominal economic growth and is likely to continue growing. In light of this growth potential, US Treasuries today look pretty expensive across the yield curve. In other words, over the longer term, the only way for yields to go is up.
Second, the large US budget deficit is unlikely to go away in a hurry. This means that a lot of new Treasury bonds will have to be issued each year to finance the deficit. Due to the low US domestic savings rate, foreign investors will be the marginal buyers of these bonds. How long will foreign buyers be interested in funding US deficits at such unattractive yields if they have little expectation that the US dollar will appreciate from current levels? At some point, their patience may run out.
The last factor to consider is the Federal Reserve, which has been doing its best in the last three years to keep yields very low. Longer term, we expect monetary policy to return to normal, which would allow upward pressures on yields to materialize.
In sum, look for near-term pressures for lower yields and longer-term pressures for higher yields.
The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AllianceBernstein portfolio management teams.
Douglas J. Peebles is Chief Investment Officer and Head of Fixed Income at AllianceBernstein.