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Running on empty

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Insights and Market Perspectives

Running on empty

Author: David Stonehouse

July 30, 2019

The dramatic rally in government bonds may be stalling after the 10-year U.S. Treasury yield’s recent dip below 2%, and could be running out of gas for an extended period of time despite the start of a new easing cycle by U.S. Federal Reserve.

Since early November, the 10-year yield has fallen approximately 125 basis points from a high near 3.25%, delivering a total return of close to 13 percent. This represents one of the strongest rallies in recent memory and emphatically underlines the market’s growing unease about the state of the global economy and the U.S. Federal Reserve’s dovish pivot late last year that now has investors anticipating multiple rate cuts by the end of the year.

Given how much yields have dropped in such a short period of time, there is little doubt that the cyclical bear market in bonds, which began in 2016, is now over. However, that doesn’t fully explain how much of the current macro environment is priced in or where bond yields may be headed from here.

Historically, when Treasuries rally following cyclical bears, they have tended to do so in two waves, with the first drop in yields giving way to a period of consolidation that, on average, backs yields up more than 100 basis points and typically lasts four or five months before the second drop takes place. This pattern has played out several times over the past 30 years, including, most recently, between 2013 and 2016 when the 10-year yield fell to its lowest level ever.

U.S. Treasuries: Rallying in waves (1989-2016)

Source: Bloomberg LP as of July 26, 2019. Yields are represented by the 10-year generic U.S. Treasury note.

The ebb and flow in yields of previous cycles has also coincided with extremes in bond market sentiment readings. For example, excessive pessimism toward Treasuries in 2013 anticipated a fall in yields that unfolded throughout 2014. Then, after that, a period of extreme optimism preceded a rise in yields, which was followed by another period of severe pessimism and second down leg for yields that ended in 2016.

Bond sentiment: An emotional roller coaster (2006-2019)

Source: Ned Davis Research as of July 2, 2019

More recently, a similar sequence has emerged with optimism about Treasuries once again reaching excessive levels after a period of severe pessimism in the fall. This would suggest an extended pause in the Treasury rally, one that could last several months, even as the Fed embarks on a fresh round of cuts to its overnight lending rate. In fact, while yields have declined going into every first rate cut by the central bank since 1989, they often rose following it and were higher, on average, 12 months later.

Yields before and after first rate cuts (1989-2007)

Date of cutYield (%)Basis point change 252 days beforeBasis point change 189 days beforeBasis point change 126 days beforeBasis point change 63 days beforeBasis point change 63 days afterBasis point change 126 days afterBasis point change 189 days afterBasis point change 252 days after
6/6/898.36-66-63-77-90-17-542311
7/6/956.05-125-172-183-1077-402273
9/29/984.59-151-117-108-851266122138
1/3/015.14-135-76-85-73-2030-52-4
9/18/074.50-30-10-6-59-30-112-34-109
Mean5.73-101-88-92- 83-10-221622
Source: Ned Davis Research as of July 2, 2019. Yields represented by 10-year generic U.S. Treasury note.

Eventually, we believe yields will drop further than recent lows—especially if the U.S. economy weakens and ends up in recession. But, for now, investors should expect the current pause in this cyclical bull market to last a while longer.   

David Stonehouse is a Senior Vice-President and Head of North American and Specialty Investments at AGF Investments Inc.

The commentaries contained herein are provided as a general source of information based on information available as of July 23, 2019 and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.

The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies.

AGF Management Limited (“AGF”), a Canadian reporting issuer, is an independent firm composed of wholly owned globally diverse asset management firms. AGF’s investment management subsidiaries include AGF Investments Inc. (“AGFI”), AGF Investments America Inc. (“AGFA”), Highstreet Asset Management Inc. (“Highstreet”), AGF Investments LLC (formerly FFCM LLC) (“AGFUS”), AGF International Advisors Company Limited (“AGFIA”), AGF Asset Management (Asia) Limited (“AGF AM Asia”), Doherty & Associates Ltd. (“Doherty”) and Cypress Capital Management Ltd. (“CCM”). AGFI, Highstreet, Doherty and Cypress are registered as portfolio managers across various Canadian securities commissions, in addition to other Canadian registrations. AGFA and AGFUS are U.S. registered investment advisers. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. AGF AM Asia is registered as a portfolio manager in Singapore. AGF investment management subsidiaries manage a variety of mandates composed of equity, fixed income and balanced assets.

™The ‘AGF’ logo is a trademark of AGF Management Limited and used under licence.

About AGF Management Limited

Founded in 1957, AGF Management Limited (AGF) is an independent and globally diverse asset management firm. AGF brings a disciplined approach to delivering excellence in investment management through its fundamental, quantitative, alternative and high-net-worth businesses focused on providing an exceptional client experience. AGF’s suite of investment solutions extends globally to a wide range of clients, from financial advisors and individual investors to institutional investors including pension plans, corporate plans, sovereign wealth funds and endowments and foundations.

For further information, please visit AGF.com.

© 2021 AGF Management Limited. All rights reserved.

Written by

David Stonehouse

David Stonehouse, MBA, CFA®

Senior Vice-President and Head of North American and Specialty Investments

AGF Investments Inc.

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