10yr yields rallied aggressively yesterday, and for no reason more compelling than a proverbial "snowball rally compounded by technicals and algorithmic trading." Ugh! I hate typing that stuff. It's annoying to be forced to reduce market movement to what feels like a "couldn't come up with anything better" type of explanation. We could also say that yesterday was the market's way of "giving up" after stocks were unable to sustain a bounce back from their rout on Wednesday. A surge lower in European bond yields didn't hurt either.
If yields can so casually blast below 1.50%, it begs the question of how low we can go. The answer is complicated, to be sure. Certainly, we already know 10yr yields can go to 1.32%. They've done that before. We can also surmise they can go much MUCH lower based on how things have played out in other major economies (Germany's 10yr was a whopping -0.76% this morning).
But entertaining the notion of another major drop in yields from present levels FEELS DANGEROUS for a few reasons. The biggest reason is the fact that the current rally is already near legendary status in terms of its size and duration--at least if we're comparing it to other rallies in the modern economic context where inflation has stabilized around 2.0%. before that, bigger rallies happened, but we were arguably correcting from the aberrant conditions of the late 70's/early 80's.
One modern example is informative, however. There too, rates were moving up from long-term lows. The economy looked like it had turned an important corner (it had, actually). Rates subsequently rushed higher, just as they did in 2018. But then doubts about the sustainability of our domestic expansion combined with a burgeoning crisis abroad led to a massive stock rout and sparked a bond rally far bigger than what we've seen since late 2018.
The year was 2011 and it is highlighted on the chart below. I grabbed that highlighted portion and overlaid it against the current rally. If the scope of 2011's rally is any guide as to what's possible in the future, it could still be very early to say the current move is at risk of fizzling out due to its success or longevity. If we merely match 2011's performance, the current rally could last almost another year and result in 10yr yields below 1.0%.
Of course all this is very speculative. We could also bounce here and never see rates this low again, but that stance seems to be harder and harder to support with facts and logic--especially as we get closer to the 2020 presidential election. Our friends at BMO Capital Markets explain:
"Our take on Trump’s attempts to achieve a compromise with Beijing is that the window of opportunity is quickly closing – the 2020 election campaign will heat up soon (as if it already hasn’t) and China is undoubtedly calculating the odds of simply attempting to wait out The Donald in hopes for a new cast of the players on the other side of the table." -Ian Lyngen, Head of US Rates Strategy, BMO
For whatever it's worth, the super long term relationship between stocks and bonds suggests a strong possibility of more bond buying. Each time stocks have begun to level off during the Great Recovery, volatility has increased and bond yields have surged below 1.60%. This time around, the increase in volatility is MUCH bigger and it probably hasn't run its course yet.
Apart from the fact that predicting the future tends to be tricky, we also need to ask ourselves how well any of this hypothetical movement could translate to mortgage rates. MBS prices have been stuck in the mud on a relative basis, and it's painfully obvious every time we look at an updated chart comparing inverted prices to Treasury yields:
While it's true that MBS definitely have room to improve versus Treasuries when and if markets calm down, it's also true that QE3 in 2012 set an unattainable pinnacle of MBS competitiveness--one that we're not likely to see again in our lifetimes (due to the unique variables surrounding the Fed's attempt to finally extinguish the smoldering embers left over from a once-in-a-lifetime mortgage crisis). Since then, MBS performance has been just a bit weaker each time we've visited the extremes. With the Fed now favoring Treasuries over MBS when it comes to balance sheet reinvestments, we simply shouldn't expect prices to be able to get back to where they were the last time 10yr yields were where they are (or where they may be going!).