Coming into 2014, Bloomberg’s survey of 67 economists showed that 97% believed that the 10-year Treasury yield would end the year higher. It started off at 3.02% and most expected it to rise into the 3.25% – 3.50% range by year-end, and with forecasts as high as 4%. Today, the yield sits at 2.33% and the 30-year Bond is closer to their prediction! The 30-year Treasury fell from 3.92% at the start of the year to 3.07% today. Why were all of these economists so wrong? We have three reasons.
1. The end of QE and the George Costanza Opposite Theory
Remember the episode of Seinfeld when George decided to do the opposite of what he would normally do in life? That pretty much sums up how the consensus should behave when it comes to the end of Quantitative Easing (QE) and the 10-year yield. Quite counterintuitively with the Fed stepping away from purchases, bond prices actually went up and yields down.
This seems be due to the market demanding less inflation protection (in the form of higher yields) during periods when the Fed’s balance sheet, shown here in the monetary base, expands.
When everyone has already sold a position, it is hard for the price (or yield) to keep moving in that direction. Case in point, it is usually best to follow the big, commercial traders (aka “smart money”) than small, non-commercial traders. In fact, most of the time, these traders are at odds with one another when it comes to trading the 10-year Treasury. The lines in the upper portion of the graph move together because we plot the inverted non-commercial traders on the right hand side (note that the top numbers are negative).
Notice how at peaks in yields, the small traders are short and large traders are long. Until small traders get long the Treasury bond (and large traders short), yields tend to fall and do not find a trough.
3. Rest of the World Needs Lower Yields
It is not just the U.S. that is awash with debt, the rest of the developed world from Japan, to Germany, to the UK all become over-leveraged and misallocated capital over the last decade. The misallocation of capital leads to a deflationary outcome due to wasteful money spent chasing poor investments. The system adapts by lowering yields to palatable levels to maintain demand for debt across the globe.
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