The United States economy is accelerating, unemployment is falling and wages are even beginning to creep higher.
Yet a huge bond market with a strong track record for predicting economic problems is flashing a warning sign right now.
The prices of Treasury bonds are rallying fiercely. The slide in oil prices has elevated concerns about growth in the global economy, and investors, as they do in times of stress and uncertainty, are seeking out the safety of government bonds.
The rally in global government debt is pushing their yields, which move in the opposite direction from their price, to astonishing lows. The yield on the 10-year Treasury note — a benchmark for mortgages and other interest rates — fell below 2 percent on Tuesday. Any investor holding that security would be paid only 1.94 percent each year, for the next 10 years. In the past, such a return would have been considered unthinkably slight.
In Europe, where the economies are weaker than in the United States, yields are even lower. The yield on the German 10-year note, for instance, fell to 0.44 percent on Tuesday. And Japan’s 10-year government security now yields an almost nonexistent 0.28 percent.
“Make no mistake, these low levels of rates are challenging the notion that we are going to see robust and constant growth,” said George Goncalves, a bond market analyst with Nomura.
Falling Sovereign Yields
The average yield of the benchmark government debt for the United States, Germany and Japan fell below 1 percent for the first time.
4
%
Yields on 10-year
government bonds
3
United
States
2
3-country
average
1
Germany
Japan
0
’10
’11
’12
’13
’14
4
%
Yields on 10-year government bonds
3
United
States
2
3-country
average
1
Germany
Japan
0
’10
’11
’12
’13
’14
In other words, the bond market is raising the specter that a period of economic growth that may have already felt lackluster to many Americans could be on the verge of losing steam.
But just how worried should one be? After all, the bond market’s pessimism might be overdone.
The United States economy grew at an impressive 5 percent in the third quarter of last year. And though the stock market has fallen from its highs in recent days, it is still trading on valuations that suggest investors see few hurdles to continued growth in corporate profits.
Also, this is Wall Street, where investors often stampede into popular trades without giving too much thought to fundamentals. And the bond market does not always get its economic predictions right. A vicious sell-off in Treasury bonds in 1994 turned out to be a false signal in a decade of almost uninterrupted growth. More recently, the yield on the 10-year Treasury plummeted to 1.39 percent in 2012, substantially lower than it is right now, and the economy did not collapse in the following months.
One of the reasons the big economies did not stall badly in 2012 was that central banks, perhaps taking their cue from red flags in the bond markets, reinvigorated their stimulus policies. Crucially, Mario Draghi, the president of the European Central Bank, said that year that he would do “whatever it takes” to prevent the euro from coming apart.
And now, once again, bond investors are hanging on European policy makers doing more. The economies of the countries that share the euro seem perilously stuck at low levels of growth. Inflation for those countries was 0.3 percent in November, a level that appears to have deeply unsettled Mr. Draghi.
“If inflation remains low for a long time, people might expect prices to fall even further and postpone their spending,” he said in an interview last week with Handelsblatt, a German business newspaper. “We are not there yet. But we need to tackle this risk.”
One way that Mr. Draghi can tackle that risk is to persuade skeptical policy makers at the European Central Bank to vote in favor of the sort of all-in government bond-buying program that the United States deployed. He appears to be getting closer to gaining such backing — and anticipation of such a program in the markets could be driving up the prices of the bonds that the European Central Bank would buy. Analysts say that the low yields in Europe are prompting investors to shift some of their holdings into higher-yielding United States Treasury securities.
But even a big bond-buying program in Europe — and continued stimulus in Japan — might not be enough to make bond markets optimistic about global economic growth.
Bearishness about growth has been evident in other markets. Stocks, which fell sharply on Monday, declined again on Tuesday. The Standard & Poor’s 500-stock index closed down 17.97 points, or 0.89 percent. The more narrow Dow Jones industrial average ended down 130.1 points, or 0.74 percent, while the Nasdaq composite index closed down 59.84 points, or 1.29 percent.
Crude oil extended its slide, falling another 2.11 percent, to $47.93 a barrel.
In the Treasury market, the price of the 10-year note rose 27/32, driving its yield down to 1.94 percent. The price of the two-year note rose 2/32 to yield 0.63 percent, while the price of the 30-year bond surged 2 9/32, to yield 2.50 percent.
It is in this market where the bearishness appears especially entrenched. Specifically, investors point out that the yield on the 10-year Treasury note has fallen by more than the yields on bonds that mature, or pay off investors, well before the 10-year note. This trend, known as a “flattening of the yield curve,” is often taken as a sign that investors think that the Federal Reserve is going to tighten policy before the economy is ready.
Raising interest rates, the theory goes, will shore up yields on Treasury bonds that mature in one or two years. But increasing rates could stifle growth and inflation, weighing on the yields on the 10-year Treasury note, which is substantially more sensitive to such economic forces. And the Fed has signaled that it might be ready to raise interest rates later this year.
“They might end up overthinking things, being too clever by half, and end up raising rates too soon,” Jeffrey Gundlach, one of the most successful bond investors, said in a recent presentation.
The action in the bond market, however, points to a bigger question: Why haven’t economies managed to grow more strongly after so many years of low bond yields? In the past, when the central bank slashed interest rates and bond yields fell, it would set off a robust revival in economic activity.
Some bond investors say the stimulus from the central banks has a decreasing effect because, each time the stimulus occurs, it increases indebtedness and stokes speculation in financial markets that fails to translate into growth in the real economy.
“The power of additional and cheaper credit to add to economic growth and financial asset bull markets has been underappreciated by investors since 1981,” William H. Gross, the famed bond fund manager, now at Janus, wrote in his monthly outlook on Tuesday. “There comes a time, however, when zero-based, and in some cases negative yields, fail to generate sufficient economic growth,” he added.
Bond market analysts, however, offer some solace by saying Treasury bonds are not necessarily forecasting an actual recession.
“We’re in the seventh inning of a business cycle and it may be coming to an end soon,” Mr. Goncalves, the analyst, said. “It is not calamity but a slowness that could linger for some time.”