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Long- and short-end bond prices have soared to all-time highs in reaction to the coronavirus outbreak and Tuesday’s surprise 50-basis-point rate cut by the Federal Reserve. Bond yields have dropped to new lows at the same time, lowering the cost of mortgages and other debt instruments. Many analysts now predict that interest rates will eventually drop below zero, following the fate of Japan and several European countries.
A healthy economy should increase demand for money, underpinning interest rate hikes that used to follow a natural business cycle. The 2008 economic collapse upset this mechanism, requiring years of quantitative easing (QE) to revive U.S. jobs and corporate profits. The economy boomed in the second half of the decade, underpinned by a massive tax cut, but the demand for money failed to increase substantially because corporations bought back stock with the windfall rather than investing in growth.
The bond market is now reacting to a worldwide economic contraction that is likely to send the United States into a major recession, or something worse. Stocks have plunged in reaction, but the Fed cut should put a floor under equities, at least in the short term. However, as we discovered in 2008, this all-powerful government body can’t revive spending when businesses and individuals cut back due to a demand shock. In turn, this suggests that the Fed will fail to stop the inevitable downturn.
The iShares 20+ Year Treasury Bond ETF (TLT) settled into a trading range after the 2000 to 2002 bear market, with support in the low $80s and resistance above $100 guiding price action. The 2008 economic collapse triggered a historic breakout, lifting the fund above $120 in a vertical advance that got repealed in the first half of 2009. It took off again in 2011, at the same time that commodities around the world were topping out following a torrid rally triggered by years of Chinese infrastructure spending.
This uptick added 10 points to the prior high while printing the first two points in a rising highs trendline that defined price action for the rest of the decade. The fund rallied into that level and reversed in 2015 at the start of a major stock correction and once again after the United Kingdom voted to leave the European Union in 2016. The election of Donald Trump a few months later triggered a major decline that bottomed out in the fourth quarter of 2018.
The Federal Reserve reversed its hawkish rate policy in 2019, underpinning a renewed uptrend that stalled a few points below the trendline in August. It settled at the 200-day exponential moving average (EMA) in the fourth quarter and took off for the stars when the coronavirus outbreak hit the newswires in January 2020. The advance reached resistance on Feb. 27, ahead of a month-end breakout that has lifted bonds into unknown territory.
The CBOE 10 Year Treasury Yield Index (TNX) topped out in August 1981, just seven months after the election of Ronald Reagan, and entered a downtrend that has now entered its 39th year. The decline has tracked a descending channel since 1993, carving an endless series of lower highs and lower lows. The index broke eight-year support near 1.35 in February 2020, descending to an all-time low below 1.00 this week.
Ominously, the channel support trendline has now dropped below 0.00, highlighting the possibility of negative interest rates later in this decade. The index hit this line five times between 1993 and 2012, so nearly eight years have passed for an event that has occurred once per 3.8 years on average. This tells us that a trend extension is long overdue, raising the possibility of a yield crash that reflects highly negative economic conditions.
The Bottom Line
Government bonds at all maturity levels have rallied to all-time highs, dropping yields to all-time lows.
Disclosure: The author held no positions in the aforementioned securities at the time of publication.
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