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Stocks Are Surging, So Why Are Bond Yields Careening to Zero?

Last Updated September 23, 2020 1:55 PM
W. E. Messamore
Last Updated September 23, 2020 1:55 PM
  • The 2-year Treasury bond yield hit a record low Friday.
  • But stock market benchmarks climbed higher at the same time.
  • Here’s what may have happened in the bond market this week.

The 2-year Treasury bond yield hit a record low of 0.105% Friday. Capital fled for safety in bonds after the Bureau of Labor Statistics reported 20.5 million jobs lost in April and a 14.7% unemployment rate . But meanwhile the Dow Jones surged 1.91% for the day.

While it seemed strange to see the stock market rally with such horrible macroeconomic data, equities knew it was coming. They had already priced in massive April job losses.

What was strange, was seeing the 2-year Treasury note yield dive while equities shrugged off the jobs report. Equities were bullish on the economy while 2-year bonds registered bears in retreat.

Historically equities and bonds typically have an inverse correlation. When stock prices go higher, money leaves the bond markets to chase bigger profits, and bond yields go up. When yields are down, that flight to safety usually entails a selloff in equities.

So why did the 2-year T-note yield drop to a record low Friday?

Bond Market Remains Cautiously Optimistic

us 2 yr treasury bond yield
2-year U.S. Treasury yield for the past three months | Source: TradingView

For one, the 2-year note was a bit of an anomaly in the bond market with lower yields for the day. Yields on Treasuries with a longer maturity, such as the benchmark 10-year Treasury note and the 30-year bond, went up on Friday .

So the bond market reflected the general optimism of investors that pushed equities benchmarks higher. And the yield curve isn’t inverted as it was last year. An inverted yield curve, when longer-term notes have lower yields and shorter-term notes, is a reliable indicator of a recession ahead.

The lower yield on the two-year note could summarize a market outlook that’s cautiously optimistic over the long term, but recognizes it may take a year or two for the economy to recover from COVID-19 completely.

Monetary Environment Could Be At Play

Stocks and bonds compete for capital. So their prices often move in opposite directions. When money flows into bonds (driving up their price and lowering their yield), it may well be flowing from an equities selloff (driving down stock prices).

The 2-year Treasury note yield steadily declined in April even as equities rose on the stock market. We saw some of that decoupling from inverse correlation in stock and bond prices throughout April in 5-year and 10-year Treasuries as well.

It could be evidence of the Federal Reserve’s lightning-swift pump of massive liquidity into the financial system. The emergency monetary stimulus is unprecedented in speed and scale. It could very well be enough to shake the traditional correlation between these asset classes and inflate the market values of securities in each.

There’s also the potential that deflation fears  are increasing demand for T-notes, driving down yields as investors seek higher real returns from a bond market in a falling price environment. A bond is a contract that pays out a fixed, nominal return. So a decrease in inflation increases the bond yield’s real value.

Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com. The above should not be considered investment advice from CCN.com. The author holds no investment position in bonds at the time of writing.