/The Tell: Bond yields set to fall further once investors come to terms with ‘sobering’ economic reality, says BofA Global

The Tell: Bond yields set to fall further once investors come to terms with ‘sobering’ economic reality, says BofA Global


Even as the COVID-19 pandemic shows signs of slowing down in the U.S. and Europe, one analyst says the tentative optimism driving the stock-market bounce and the rise in yields for government paper is unlikely to last.

Carol Zhang, a rates analyst at Bank of America Global Research, says investors have assumed as long as the pandemic was brought under control, the economic damage could be reversed swiftly. But few investors appear to have seriously contemplated “the sobering economic consequences some countries will inevitably face” even after the pandemic passes, she said, in a Tuesday note.

The slowing in the growth of the number of infections in European countries and New York City, the center of the outbreak in the U.S., in recent days has given a lift to investor sentiment, amid renewed hopes that the economy will soon return to normal.

The S&P 500
SPX,
+2.11%

index may post back-to-back gains Tuesday, leaving it up nearly 9% week-to-date. Those gains, in turn, have weighed on values for haven assets like U.S. Treasurys, pushing the 10-year U.S. note yield
TMUBMUSD10Y,
0.778%

up more than 16 basis points in the past two days and leaving it at 0.753% at last check.

Zhang points out investors saw a similar combination of dysfunctional markets, a supply shock and aggressive policy responses in the 2008 financial crisis. Panic over the banking sector’s health peaked in the September of that year when Lehman Brothers collapsed.

But bond yields didn’t bottom out until a few months later as investors began to digest the economic implications of a seismic financial crisis and a broken housing market. From hovering at around 4%, the benchmark 10-year yield plunged to 2.06% at the end of 2008, as shown in the chart below.

Treasury yields tend to fall if investors are expecting a recession or a sharp slowdown in economic growth as it can lead to lower inflation prospects.

Rates didn’t bottom out until the end of the year

Likewise, once investors realize a return to normalcy will remain elusive, bond yields are likely to head even lower from current levels despite the U.S. government’s yawning budget deficits and the necessity for the Treasury Department to finance trillion dollar economic rescue stimulus packages.

“In a few weeks’ time, the world will still need to wrestle with disruptions in everyday activities, supply-chain hiccups and social unrest around the world, all hurting the labor market, consumer confidence and investor risk appetite. Pricing in such a reality means the ‘lower for longer’ theme has just become ‘lower for a lot longer”, Zhang said.

See: Stock market is headed for choppy waters amid worries that a return to normal will elude the U.S. economy

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