Quietly, over the past several months, the market for U.S. bonds has been tightening. After benchmark yields have spent much of 2015 in a range above 2.2%, the flight out of equities has poured investor funds in the safety of Treasurys, driving 10-year yields to fresh 4-month lows. The yield on 10-year Treasury notes fell as low as 1.92% on Monday morning before settling back around 1.98%. This was the first time the 10-year note had seen its yield fall below 2 percent since April, indicating a surge in demand.
What's all the fuss over Treasurys? Amid the turmoil last week that saw the precious metals make much-awaited advances at the expense of equities, bondholders also saw their fortunes brighten at the Treasury market rallied to $67 billion in gains over the week. This trend may not be directly related to the dollar, as the Greenback fell by 2.4% against a basket of its peers on Monday, cutting into what's been a solid bull run for the dollar over the last year.
Concerns Over China
The jump in government bonds is influenced mainly by the market meltdown in China that has been weighing on investments around the globe. As China faces a wide range of risks in its economy—from slowing manufacturing, weaker demand for raw resources, a swift stock market correction, and a surprise currency devaluation—investors must find safer places to park their money and shield themselves from exposure to the downturn in China. This is easier said than done now that Chinese markets make up such a bigger part of the global financial infrastructure than was the case 20 years ago.
Several traditional safe haven assets, such as gold and the Japanese yen, did see demand in the wake of the massive selloff in stocks last week that dragged on to Monday. The biggest gainer, however, was in government bonds: 10-year German bunds, Japanese bonds, U.S. Treasurys, as well as government bonds in Australia, New Zealand, South Korea, France, and Canada all saw yields fall by multiple basis points.
Treasurys and Fed Expectations
The crowding into government bonds across the globe is a natural response to money flowing out of equities; when investors expect stocks to move lower in the future, their money is better spent on the relative safety of government debt. They are willing to exchange risk for safety and a modest yield.
There is special implication for U.S. and U.K. bondholders, however. Because both countries' central banks are expected to raise interest rates soon, purchasing a Treasury or a Gilt today means potentially missing out on a much better yield in just a few weeks or months when benchmark rates are expected to rise. With 10-year yields already well below 2% (still far higher than much of mainland Europe), U.K. Gilts saw a selloff that drove yields 10 bp higher. The opposite seems to be happening in the U.S.
With this in mind, the piling into Treasurys in some respects reflects market expectations that the Fed won't raise rates this year, at least not in September. For perspective, in just one week, analysts' expectations for a September rate hike fell from 50-50 to 34%; before the July meeting minutes of the FOMC were released last weeks, over 70% of these same analysts believed a September move by the Fed was imminent. By contrast, the Bank of England may now be the first central bank to tighten monetary policy if the Fed holds back in September.