A quick look at the market shows something fascinating: stocks continue higher while the 10-year Treasury yield creeps back to below 2%. Last week, yields on the 10-year Treasury fell to 1.84%. We seem poised to return to 10-year yields consistent with yields during the worst of Greek debt crisis fears.
So what’s up with the 10-year?
10-Years’ Signals to Investors
The 10-year Treasury throws off a variety of signals to investors including:
- Implied inflation – If Treasuries are risk-free, a little conceptual algebra lets us know that the yield for any given US Treasury bond is pure inflation expectations.
- Risk-appetite – When investors go risk-off, Treasuries are the place to be. Think of it like an FDIC-insured bank for investors with too much capital to go open thousands of $250,000 savings accounts.
- Credit risk – The US dollar is still the most liquid currency in the world. When credit crises hit, they hit hard. While the US financial crisis and credit crunch hit the US, it hit non-reserve currency countries even harder. Keeping cash in dollars is a good way to make sure you can move it at a moment’s notice.
Investigating the 10-Year Yield Chart
The Chicago Board Options Exchange has a contract for the 10-year Treasury yield. You can look it up at Yahoo Finance under the ticker ^TNX.
Here’s a quick look:
As you can see, the 10-Year Treasury yield is retesting lows last seen during the Greek debt crisis. Greece’s debt crisis is hardly over. In fact, I spot a few interesting correlations between recent events and the 10-year yield:
- March Peak – The March peak is consistent with a risk-on move to riskier assets, including stocks. The S&P500 rallied to year-to-date highs during the period.
- European bailout – American investors hardly noticed what was going on in Europe in March. During the period, the European Central Bank loaned 529.5 billion Euros (roughly $890 billion) to banking institutions on a 3-year maturity at 1% annual interest. Likely, these loans allowed banks to temporarily move cash out of US Treasuries and into riskier assets.
- Move back to safety – Following Greek elections of anti-austerity politicians and an election in France that gave an anti-finance socialist politician the French presidency, financiers around the world are worried Greece’s debt issues won’t be solved any time soon.
Low Rates: Use ‘Em or Lose ‘Em
For individuals, lower rates are a boon. As the US Treasury yield is the benchmark for risk-free lending, it is also the benchmark for mortgages, student loans, car loans, and other financing for consumers. Banks take the 10-year rate, slap a premium on top, and offer the rate to borrowers like us.
So how can we make the best possible use of low-rates and fears in Europe?
- Refinance – Seriously, if you’ve yet to refinance, you’re missing out on what might be the best rate you have ever seen in your life (table to current rates in your state). Mortgage rates share a perfect correlation with the 10-year US Treasury, which rarely yields less than 2% per year.
- Rebalance – Unless you’re nearing retirement, you have to start accepting more risk in your investments. The reality is that bonds are trading for very lofty premiums, while inflation threatens your total potential return. While no one wants to pay too much for stocks, no one wants to pay too much for bonds, locking in a guaranteed loss when one considers the rate of inflation going forward. Countless dividend-paying stocks yield more than the 10-year US treasury yield, and despite their own premium, dividend-paying equities still have the opportunity for capital appreciation if stock markets rise.
- Leverage? – Those who haven’t been keeping pace with their retirement contributions might want to consider leveraging with a cash-out refinance or a longer amortization schedule on their mortgage. Given the tax benefits of mortgage debt and a paltry 30-year fixed rate of 4% for mortgage loans, it might be high time to think about playing catch up with other people’s money.
Events like these don’t happen very often. Generally, bond yields should rise as stocks rally, but the current market is breaking from historical norms.
How do you plan to use low rates?
Have you rebalanced your retirement to reduce bond exposure to increase stock exposure?
Do you think low rates are sustainable for the long term?