Could US 10 year Treasuries fall to 0% yields?
OK, we are being more than a bit provocative and the thought comes from our friends at CrossBorder Capital. But they have form in this - before the 2008 crisis they predicted that interest rates would fall to close to zero.
Their approach is based on the ‘liquidity’ data they collect every month, which over time has proven a strong predictor for many variables and particularly at turning points in markets. Last autumn they suggested that the Fed funds rate had peaked at 2.5%. At that time the Fed was still talking an upward path of many more rises.
CrossBorder’s conclusion was based on a severe restriction in the amount of liquidity available, suggesting that monetary conditions were already far tighter than the consensus believed.
Since the GFC there has been a shortage of ‘safe’ assets such as Treasury bills and commercial paper, and they are increasingly concentrated in the US. They are needed, as we wrote last month, to collateralise the wholesale funding markets which - since solvency rules have made it so much more difficult for banks to lend - underpin much of the world’s finance today.
The shortage of these ‘safe’ assets is creating demand for assets further out on the maturity and credit scale. That is why US (and some other G7) bond yields have fallen along the curve. It is also in our view why the Fed changed tack so abruptly in January: if the wholesale markets freeze from a shortage of ‘safe’ collateral assets, it would cause systemic risk to the commercial funding system in a way not dissimilar to what happened to mortgage markets in 2007/8.
So could US 10 year Treasuries fall to 0% yields? If demand for these ‘safe’ assets becomes a panic, it could indeed push yields down to German or Japanese levels. On the flip side, governments of both left and right are using fiscal policy as a lever and that implies greater supply. But we do expect yields to continue to go significantly lower. If they do reach 0%, remember you heard it here first!
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