The US 10-Year Note is the most important fixed income instrument in the world. Its yield determines the borrowing costs for countries, companies, and consumers while the Note itself acts as a haven asset during periods of market and economic stress. It might be impossible to overstate the importance of the US 10-Year Note to the functioning of the global economy and global capital markets. It might also be impossible to overstate how closely investors follow its pricing and what it might mean for other asset classes and the state of the economy. With that said, what should we make of a US 10-Year Note yield of 0.52%, essentially the lowest in its history? One way to answer is via three buckets: the good, the bad, and the (possibly) ugly. The good is low yields “flatter” many major asset classes, including stocks and housing. The bad is investors are hard pressed to find safe sources of adequate income, and any entity with long-term liabilities – think insurance companies or pension plans – must raise more capital or take on more risk to meet those liabilities. The (possibly) ugly is a historically low yield on the US 10-Year Note is indicative of tougher economic times ahead. We are very confident the good and bad buckets are unchallengeable. For example, low interest rates make future cashflows worth more, which supports a higher price to earnings ratio for stocks, but low interest rates also make future liabilities more expensive, which requires a higher rate of return and/or more capital to meet those liabilities. However, we are not willing to concede the point that low yields reflect a global economy failing to find its footing, which is why we labeled our third bucket the (possibly) ugly. Instead, we think the interest rate environment reflects the extraordinary – and successful – efforts by the Federal Reserve and other central banks to lower borrowing costs for countries, companies, and consumers with an eye toward mitigating the severity of the COVID-19 driven downturn, little to no inflationary pressure, and an aging global population increasingly interested in capital preservation over capital appreciation.
Tagged: weekly wire, market perspectives, Tim Holland, US 10-Year Note, COVID-19, Federal Reserve