2019 was a baffling year for bonds. The 10-year U.S. Treasury yield fell to a three-year low, and the yield curve flashed ominous signals about the economic outlook. We’ve seen some improvement in long-term yields since the September low, but we don’t expect much more upside in 2020. Even in a low rate environment, bonds can still play an important role in helping to diversify portfolios.
One of the biggest challenges in 2019 was explaining the bond market’s baffling signals. Many firms kicked off 2019 with expectations of rising rates after the Federal Reserve’s (Fed) December 2018 rate hike. Then, the macroeconomic environment made a turn. Trade tensions between the United States and China intensified, and global economic data deteriorated. Global fixed income investors turned to U.S. Treasuries for income, safety, and liquidity, adding more pressure on yields. The 10-year U.S. Treasury yield fell to a three-year low of 1.46% on September 4, and the Treasury yield curve inverted (long-term yields falling below short-term yields). Thankfully, the Fed eased tensions with three straight rate cuts from July to October. Policymakers’ actions seem to have renewed investors’ confidence.
Long-term yields could creep higher in 2020 if global economic conditions improve and Treasury buying eases. The gap between U.S. and international yields should continue to persist, and global buying pressure to keep a lid on U.S. yields. Global yields may stay unusually low until growth and inflation pick up materially in Europe and Japan. With the benefits of monetary policy largely exhausted, that may take a while.
The yield curve’s inversion was arguably the biggest fixed income news of 2019. The spread between the 2-year and 10-year yields fell negative for eight trading days, while the spread between the 3-month and 10-year yields was negative for five months. Investors were understandably concerned. In the past five economic expansions, the U.S. economy has peaked an average of 21 months after the spread between the 2-year and 10-year yields initially turned negative. The yield curve’s inversion was a concern, but it may have been more a sign of too tight monetary policy instead of a sign of an imminent recession. The steepening of the yield curve in the latter half of 2019 is similar to what occurred last year. We will have to wait to see what happens next. Perhaps the unusual rate environment has made the yield curve’s economic signaling less meaningful than it has been in the past. We will be watching for either the spread between the 3-month and 10-year yields to fall below -0.5%, or for the 2-year and 10-year yield spread to invert for 90 days.
In the past, those occurrences have been more predictive of a near-term recession. Muted yields and late-cycle economic growth could be a tricky environment for fixed income investors to navigate in 2020.
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- Data provided by LPL Financial.
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