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The 10-year Treasury yield was 14% in 1984 and is now just half of one percent. For most of that time, dips in Treasury yields were a reliable indicator of economic weakness ahead. Today, that no longer seems to be the case. Lisa Shalett from Morgan Stanley believes this has important ramifications for portfolio construction and is closely watching falls in gold prices which would warn a bottom of real yields.

Key quotes

“Long-term government bonds may no longer be the best option for yield or capital preservation with rates so low. Indeed, the ‘real’ yield you stand to earn on a 10-year Treasury note is now negative one percent when inflation expectations of around 1.5% are factored in. Also, investors have grown accustomed to valuing equities based on their earnings potential relative to the yield on a Treasury. That method may not work as well going forward and could be fueling some of the excessive valuations we’re seeing now, especially in tech stocks.”

“Action by the Fed has so far proven effective at relieving the pandemic’s worst potential economic damage. That said, these policies can come at a cost. I’ve recently discussed high valuations in tech and other growth stocks. To this, I’ll add apparent excessive risk-taking in corporate credit markets, the rapid appreciation of commodities like gold, and the depreciation of the US dollar.”

“There is also potential for longer-term interest rates to move higher if inflation expectations continue to rise. Investors should watch for a potential dip in gold prices, which could signal that real yields are set to bottom.”