Forget all the Election 2016 ruckus. Investors around the world don’t care. They think U.S. government bonds are the safest place to park their money right now.
There’s so much demand for U.S. government bonds that America can borrow money at record low rates. Foreign investors can’t get enough of these bonds, and while that sounds like good news for the U.S., it can also be problematic.
On Tuesday, just after the July 4th Independence Day weekend, the yield on the U.S. 10-year government bond fell to its lowest level ever: a mere 1.36%, according to Factset.
That broke the record set in July 2012 when investors were hungry for U.S. bonds as the crisis in Greece and near-crisis in Spain scared many away from Europe. The yield hit 1.387% then, according to Bloomberg.
“The mood has soured again,” says strategist Kit Juckes at Societe Generale.
U.S. bonds are better than foreign ones
Investors are willing to accept incredibly low levels of interest because a lot of government bonds in Germany, Japan and elsewhere in the world have negative yields. In other words, you basically lose money to buy bonds in many European countries right now.
Suddenly, the U.S. looks incredibly generous with its rates under 1.4%.
“The reality is if you’re a European investor or you’re looking at yields in Europe, our [U.S.] yields look attractive, as crazy as it sounds,” says trader Tim Anderson of MND Partners.
There’s now a record $11.7 trillion worth of government bonds trading at negative yields, according to Fitch Ratings.
But Anderson is one of many warning that this massive flight to safety on America’s shores can be dangerous.
“I worried that I’m buying a bubble,” says Anderson. Not only is there fear of a bond market bubble, but Anderson says the low bond yields could be artificially propping up the stock market.
Why this is a problem for U.S. investors
U.S. stocks remain very close to their all-time highs. Yes, American stocks took a hit after Brexit, but they recovered quickly. Anderson points out that a lot of the stocks doing the best right now are companies like Johnson & Johnson (up almost 20% this year) and Kimberley Clark (up nearly 10%) that have high dividends. It could be a sign that investors who would have bought bonds are instead buying riskier stocks in an effort to get more yield and return. If that’s the case, stocks could take a hit as soon as rates start to go up.
That’s not all. The other red flag is that all this U.S. bond buying sends the dollar even higher. It’s already very strong compared to the euro and yen, not to mention the British pound, which tumbled to its lowest value since 1985 after Brexit.
A strong dollar hurts U.S. trade. Goods made in the USA look very expensive on world markets.
It would be one thing if this were just a temporary trend, but traders are seriously asking: how low can yields go? It’s new territory for investors — and central banks — as the U.S. Federal Reserve tries to figure out whether this will be a drag on the economy.
Bond expert Jim Vogel of FTN Financial says get ready for U.S. yields to go even lower: 1.25% is a real possibility.