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)
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)
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 cut | Yield (%) | Basis point change 252 days before | Basis point change 189 days before | Basis point change 126 days before | Basis point change 63 days before | Basis point change 63 days after | Basis point change 126 days after | Basis point change 189 days after | Basis point change 252 days after |
|---|---|---|---|---|---|---|---|---|---|
| 6/6/89 | 8.36 | -66 | -63 | -77 | -90 | -17 | -54 | 23 | 11 |
| 7/6/95 | 6.05 | -125 | -172 | -183 | -107 | 7 | -40 | 22 | 73 |
| 9/29/98 | 4.59 | -151 | -117 | -108 | -85 | 12 | 66 | 122 | 138 |
| 1/3/01 | 5.14 | -135 | -76 | -85 | -73 | -20 | 30 | -52 | -4 |
| 9/18/07 | 4.50 | -30 | -10 | -6 | -59 | -30 | -112 | -34 | -109 |
| Mean | 5.73 | -101 | -88 | -92 | - 83 | -10 | -22 | 16 | 22 |
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.
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.
© 2023 AGF Management Limited. All rights reserved.
Written by
David Stonehouse, MBA, CFA®
Senior Vice-President and Head of North American and Specialty Investments
AGF Investments Inc.
