April 24, 2015 | By Scott Minerd, Global CIO
For the past 30 years, 10-year U.S. Treasury yields have shown a clear downward linear trend, falling from over 10 percent in 1985 to less than 2 percent today. Around this linear trend, yields have also exhibited a fairly consistent cyclical fluctuation, with the size of the fluctuation about 200 basis points from peak to trough, and with the cycle repeating every six years. This fluctuation can be thought of as a sine function, allowing us to model 10-year yields by combining the sine function with the linear trend (see Chart).
If we assume the secular, linear downward trend in yields will continue in the near term, we can predict the short-term outlook based on the model of cyclical fluctuations. This model currently shows that rates are just beginning to undershoot the linear trend, with the model predicting that rates will bottom at 0.82 percent in March 2016. What’s even more interesting is that the average actual bottom in rates has been 73 basis points lower than the model predicts, which would put rates at just 0.09 percent.
Now, I am not necessarily predicting that U.S. 10-year Treasury yields will test zero like its counterpart the German 10-year bund, which currently stands at around 16 basis points and I believe could provide negative yields at some point. What I am saying is that there are many powerful secular and fundamental forces at work that signal the risk to U.S. interest rates remains to the downside.
With Federal Reserve tightening drawing closer, the continuation of this downward trend could be called into question. However, a number of factors, including lower first quarter gross domestic product (GDP) growth, high demand from overseas investors (with yields approaching negative territory in much of Europe), and expectations of a slow liftoff by the Fed, are working to exert downward pressure on U.S. yields, thus limiting any upside in rates in the near term. The prospect of a stronger dollar as a result of upcoming U.S. rate hikes only serves to heighten foreign demand for U.S. Treasuries. International investors are likely to seek to preempt Fed action and invest while their currency has greater relative strength. Betting against the downward trend in U.S. rates has proved to be a widow-maker trade for many years—and with fundamental and technical factors pointing to downside risks in rates in the near term, there appear to be few reasons to bet against the trend now.
For the past 30 years, 10-year U.S. Treasury yields have shown a clear downward linear trend, falling from over 10 percent in 1985 to less than 2 percent today. By applying a sine function to these deviations, we can predict deviations from the linear trend. The model projects that rates will reach a cyclical trough in March 2016. Assuming the linear downtrend continues, this would put the U.S. 10-year Treasury yield at 0.82 percent.
Source: Bloomberg, Haver. Data as of 4/17/2015
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