Yields on 10-year Treasuries broke below 2% for the first time since 2016 this week after the Federal Reserve signaled it’s ready to lower borrowing costs, prompting a flurry of bets that a rate cut will happen in July. The U.S.-China trade dispute remains hot. On Friday, the U.S. Commerce Department barred five more Chinese entities from buying American-made products. And now, we are in the early stages of tense negotiations with Iran.
Benchmark 10-year Treasury notes completed their seventh straight weekly rally on Friday. The yield has shrunk to 2.05% from 2.53% in May. Fed rate cuts in July and September should help push those yields down to 1.85% by year-end. And, the strong dollar is underpinning a rally in U.S. government bonds, as rising global trade tensions stoke demand for safer assets. Consequently, falling yields have taken bond prices to the highest level seen in years.
The sentiment amongst investors is – When the rest of the world is struggling and the outlook is uncertain, it makes sense to take refuge in haven assets like bonds, treasuries and defensive names, and the longer that the uncertainty around trade issues remains outstanding, the longer these investments will be supported.
Future Wealth’s View
One of the most important questions is whether the Treasury rally is signaling that a U.S. recession is imminent. While we see real GDP decelerating into the second half of 2019, we do not yet see the prospects of an actual recession in the near future given the low unemployment numbers. If that read is correct, then what is driving the U.S. bond market rally?
The bond rally could be signalling that the effects of trade war could be worse than expected and Q2 corporate results could reflect that next month. Simultaneous rebounds in the stock and bond markets are clearly sending conflicting signals about the direction of the economy. The recent trade war developments have largely halted the upward momentum in U.S. equities although the S&P 500 inched into record territory earlier this week.
At Future Wealth, since the first talk of trade war with China earlier this year, we have been loading our client portfolios with Treasury Inflation Protected Securities (TIPS), defensive high dividend stocks and a decent amount of bonds. While our clients may have given up a bit of return from our underweighting of S&P 500 stocks, long term capital preservation over near term appreciation appears to be the judicious strategy, in our view.