To Some Investors, 10-Year Treasury Note Isn't What It Was

It was once every investor's touchstone. Now, the 10-year yield 'has apparently lost any heartbeat.'

For years, the 10-year U.S. Treasury note has been every investor's touchstone. Now some people are saying they can't trust its signals the way they once did.

The yield on the benchmark U.S. government security, long a key economic barometer for financial markets around the world, barely budged in response to Friday's better-than-expected jobs report. It now enters the week parked near record lows around 0.55%, with investors preparing to parse stimulus talks, data on inflation and new tensions between the U.S. and China.

That is near the bottom end of the narrow range in which the yield has stalled for months, frustrating those who have long expected it to rise when investors are feeling optimistic about growth and inflation and fall when their outlook dims.

The yield "has apparently lost any heartbeat," wrote Peter Boockvar, chief investment officer at Bleakley Advisory Group, after the report.

U.S. government bonds have rarely been in greater demand than during this year's pandemic-fueled market mayhem. Asset managers scooped up Treasurys to cushion portfolios when stock markets unraveled in March until banks were hamstrung by investors' simultaneous flight to cash and the market temporarily dried up.

Then the Federal Reserve intervened, dropping interest rates to zero and buying billions of dollars worth of Treasurys weekly to boost lending and stave off economic calamity. Now the central bank is preparing to abandon its three-decade-old practice of pre-emptively lifting rates to tamp down inflation, allowing for periods in which prices rise at a faster pace than its 2% target.

The combination has depressed the 10-year yield, leaving it stuck even as stocks rebound and measures of investors' inflation expectations rise. That leaves some contending that the 10-year note is losing its qualities as a window on the economy, a hedge against nosediving stocks or a producer of steady, low-risk investment income.

"Government bonds have less room to rally if things go wonky," said Elga Bartsch, head of markets and economic research at the BlackRock Institute, the investment-analysis division of the world's largest asset manager.

Pension funds, endowments and people saving for retirement have long assumed that when times got tough, they could park their cash in Treasurys, a risk-free asset that still produced returns. In 1987, when Black Monday sent stocks tumbling, the 10-year note yielded nearly 10%. When Lehman Brothers declared bankruptcy in September 2008, the yield was around 3.5%. Now it has closed below 0.6% for two consecutive weeks.

Wall Street economists hotly debate the reasons behind the decadeslong decline, citing factors including central-banks policy, low growth and inflation and demographic shifts. Market-based measures of inflation expectations suggest even after the economy recovers from the pandemic shutdowns, investors anticipate a return to slow growth and low inflation.

The stability hasn't quieted some longstanding worries. Some observers fear trade tensions with China could spur officials to pare the country's roughly $1.1 trillion of Treasurys, though many deem that unlikely because that would hurt the value of China's own holdings, including extensive stores of dollar-denominated stocks and corporate debt.

And while the Fed believes the pandemic and related job losses are disinflationary, others see new strains from the trillions in government borrowing aimed at limiting the economic damage. That could power a pickup in inflation, which tends to hurt the value of bonds by eroding the purchasing of their fixed payments.

BlackRock Inc. said it is reducing the amount of sovereign bonds it typically purchases and is buying more Treasury inflation-protected securities, or TIPS, which compensate bondholders if inflation rises. TIPS yields have fallen sharply this year.

"You need more diverse hedges than in the 1980s," said Rick Rieder, chief investment officer of global fixed income at BlackRock. "And what you hold as assets has to be different. We haven't ever seen this dynamicwhere the willingness to functionally print money to get to the other side of a tough shock to the system is so big." As a hedge against stock declines, Mr. Rieder said the 10-year note earned a grade of "B-minus at best." He is also holding gold to protect against inflation.

Ashok Bhatia, deputy chief investment officer for fixed income at Neuberger Berman, said TIPS are just a part of a diversified solution to compensate for low yields and that some asset managers are rotating into corporate bonds, asset-backed securities and agency mortgage-backed securities now that the Fed "is providing quasipermanent support."

The Fed formally opened a $500 billion lending program in June to support issuance of new debt by large corporations, while also adding to purchases of existing debt. The move boosted the appeal of highly rated corporate debt, leaving investors buying more company bonds than usual because they offer higher yields and now come with an implied backstop from the Fed, said Chris Stanton, chief investment officer of Sunrise Capital Partners.

"You never would have replaced the 10-year with investment-grade corporate debt in the past," said Mr. Stanton. "You bought sovereign debt because companies could default."

Investment-grade corporate-bond yields are trading around all-time lows, according to Bloomberg Barclays data. Daily volumes in debt linked to the highest-rated companies surged 35% to $99.5 billion in the first half of 2020 compared with the same period a year earlier, according to JPMorgan Chase & Co. research analysts.

Some traders and analysts say the 10-year note is irreplaceable because it remains the world's primary risk-free asset. To them, the safest corporate bond makes a poor substitute because even the strongest companies can go out of business. The U.S. government, on the other hand, can print its own money.

There also are structural reasons for the 10-year note to persist at the center of global finance. Hedge funds, for example, use it to fund a popular strategy known as the basis trade, which seeks to exploit pricing gaps between Treasurys and futures.

"It is a very unique instrument because you don't have to worry about not getting your money back," said Mr. Bhatia. "The minute you move to other investments, you break the barrier of a true risk-free asset."

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