Has anxiety gotten the better of Treasury yields?

Thus far in 2014 (through Friday, May 2), government bonds have gained more than the Dow Jones Industrial Average, pushing yields to their lowest levels in six months and further delaying investors' fear of an imminent rise in interest rates (data: Barclays, via Dow Jones). Why is it that bond yields insist on being so defiant? Likely factors include:

  • Geopolitical fears. Investors can't find solace when there is constant turmoil in the Middle East and Eastern Europe, not to mention other regions around the globe.
  • Uncertainty about global economic growth. The data aren't quite as convincing as many would like, and analysts believe global growth could be susceptible to a pending shock, whether it's a dramatic slowdown in China or tumult related to the Crimean region of the Ukraine.
  • Weaker-than-expected growth in the United States. In what has been a long-running story, the U.S. recovery has been slow, hampered by persistently low inflation, a relatively weak consumer, and sticky unemployment (amid other measures). Until investors see stronger signs of life in the U.S. economy, it is likely that so-called “safe haven” Treasurys could continue being supported by strong demand.

No breakout on the horizon

So far, expectations at the beginning of the year — for better economic growth and higher yields — have not been borne out. Simply put, markets are suggesting that a shift away from Treasurys is still viewed as a risky move. It's very likely that these circumstances could continue into the coming quarters, in our opinion.

Of course, if the U.S. economy continues its glacial pace of recovery, there's a chance that yields could rise, but the slightest reason for a flight to quality (as is evident today) could continue testing yield levels. Furthermore, when you factor in a still-accommodative U.S. Federal Reserve and very modest inflation, we believe interest rates should generally stay low, and our analysis suggests they probably won't test anything above 3.5% in 2014.

The views expressed represent the Manager's assessment of the market environment as of May 9, 2014, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice.

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05/14 (12591)

Notes from the desk