Wall Street Journal
NEW YORK—Fears about Europe’s debt crisis and the U.S. economy appear to be easing, but the flight into safe-harbor Treasurys hasn’t reversed as sharply as might be expected given the rally in stocks. That is because of the U.S. Federal Reserve’s heavy hand in the market, analysts say, which is seen keeping a lid on Treasury yields even if conditions in Europe and the U.S. improve.
Prices of stocks and Treasurys usually go in opposite directions, because interest in riskier assets such as shares often comes at the expense of safe, but low-yielding, Treasurys. In recent weeks, however, the stabilizing landscapes in the euro zone and the U.S. have revealed diverging viewpoints from the stock and bond markets. « The Federal Reserve has been very, very vocal about the length of keeping rates lows, » said Ray Remy, head of fixed-income trading at Daiwa Capital Markets America. « That in effect takes away your inverse relationship, and it can last for a while. »
As the European debt crisis deepened into fears about potential contagion to the region’s financial system, the six-month correlation between the Standard & Poor’s 500-stock index and 10-year Treasury yields, which move inversely to prices, hit as high as 0.94 in October. A reading of one means the two markets move in perfect unison. A zero suggests there is no pattern in the relationship.
That same correlation has plummeted since the start of the year, to 0.01 as of Friday.
For months, there has been a lack of reaction in Treasurys as reports have showed the U.S. economic recovery gathering steam.
The European Central Bank’s decision to offer banks three-year loans at low interest rates in December and again last month also eased fears about a liquidity crunch.
These developments have helped the S&P 500 gain 14% since a Dec. 19 low. But instead of rising, 10-year Treasury yields have floated within a tight quarter-percentage-point range in that same period. The yield on the 10-year Treasury was at 1.983% late Friday. Some analysts say these low yields reflect the hard time investors are having in fully forgoing U.S. Treasurys despite their paltry yields.
« Bond people worry, » said Didi Weinblatt, vice president of fixed-income investments at USAA. « And whenever people get worried about anything, they’ll still buy Treasurys. »
True to bond investors’ glass-half-empty reputation, doubters rmeain in the bond market despite recent improved signals on the euro zone and the U.S. economy. Participants continue to express concerns about Greece’s ability to follow through on debt-reducing overhauls, while others say they want more than a few months worth of evidence about the U.S.’s recovery. This week, the U.S. will release a slew of economic indicators, including service-industry data Monday and the closely watched nonfarm-payrolls report Friday.
The Federal Reserve and its bond-buying program is the other force still around to keep Treasury yields low.
« Our yields are artificially suppressed. This isn’t a normal market, » said Leslie Barbi, portfolio manager and head of fixed income at RS Investments.
Her fund is underweight U.S. government debt because Ms. Barbi believes 10-year yields would easily be above 3% if it weren’t for the Fed and Europe.
Of course, artificially contained yields also run the risk of snapping higher if investors begin catching up with the upbeat economic signals. But for now, analysts expect a breakdown in the U.S. stock-to-Treasurys correlation to persist.