Two weeks ago, I theorized for a Bankrate.com expert poll that the 10-year yield could go below 1% if headlines about coronavirus in the U.S. got worse.
Within those two weeks, the news did get worse, and this resulted in panic bond buying. Last week, I discussed for the first time in this cycle what I believe the 10-year yield would look like if we were actually in a recession.
If all six flags in my six recession red flag model were up, the first thing I would say is that the 10-year yield can be in the range of (-0.21 – 0.62%).
Yes, I said it, negative rates.
Where we are now:
Sunday night, the plunge in oil prices due to the Russian and Saudi Arabia OPEC war and worsening headlines from the COVID-19 outbreak took yields below .5%.
By Monday morning we were in the low .30’s with the 10-year yield. As of Tuesday morning, it was trading at .65%.
So we’ve already reached the level that I believe we would see in a recession on the 10-year yield. We can anticipate at least two quarters of stunted growth in Q2 and Q3 due to factors I have talked about above.
That said, we’ve had three negative GDP quarters in this record expansion, four of which were under 1%, and two back-to-back quarters of .5% growth in 2012.
The U.S has had periods of slow to negative growth that quickly popped back up to positive growth. It shouldn’t shock anyone if growth in Q2 and Q3 is very weak or even if one of those quarters has negative growth. Once the world defeats this virus our economy should be growing again at a slow but steady pace.
Questions of how long and to what scale COVID-19 will have its grip on our economy have created an atmosphere of uncertainty and insecurity, even though recent economic data has gotten better.
Take, for example, the robust jobs report last Friday, which under normal circumstances would have been hailed as almost impossible since the three-month moving average ran up to 243,000 jobs per month.
For the markets, however, it is not about “what have you done for me lately,” it’s all about what the future holds.
Currently, less 1000 cases of the virus have been identified in the U.S., but as testing becomes more available and widespread, those numbers could dramatically increase. If the U.S. follows the same trajectory as Italy, where the number of infected went from around 200 to over 7,000 in weeks, I anticipate increased anxiety over COVID-19. This can also lead to the government authorizing more measures to stop the spread of the virus.
Where are we headed?
Will all this uncertainty drop the 10-year yield negative and bring 1% mortgage rates to America anytime soon?
The short-term answer is no.
My bond market forecasts for the 10-year yield have been the same for many years: in the range 1.6% to 3% – and, true to the model, it has stayed in that range for the majority of this expansion.
As the longest economic expansion continues, only a few events have been able to drive the 10-year yield below 1.6%, taking mortgage rates lower but never under 3%. It’s been challenging to convince people that we should have a 2-handle on mortgage rates if we’re going into recession.
Considering our current dramatic circumstances, is a negative 10-year yield in America out of the question? Other countries have had negative yields without being in a recession. We are not like Japan or Europe yet, but when the U.S. does go into recession, I expect the odds of getting below zero to look more realistic.
Before I utter the recession word, however, I need to see my last three recession red flags raised.
One thing people have to be mindful of now is that China wants to get back online, so they’re going to be sending people to work soon. If we get a second wave of coronavirus increases in China, that is a headline risk that can send yields lower.
Since 1981, mortgage rates have decreased 2% or more in each new cycle, and this has assisted with growing the housing market.
Current rates are already so low that for that to happen again, we would need to see yields go and stay negative for a long time. Unlike other economies, the U.S. can still create inflationary demand, and this why our yields are higher.
So, while I am a firm believer that we will see a negative 10-year yield in the next recession, I am not confident of how long it will last.
This means we won’t see 1.25% – 2.25% mortgage rates with a long duration, thus snapping the four-decade streak of 2%+ lower mortgage rates that housing has enjoyed.
We might be able to crack under 2% for a brief time, but the duration won’t be like what we have seen in this record expansion in which rates have been below 5% but not under 3% since 2011. (See below).
Only the virus knows if this week’s 10-year yield low in the low .30’s will be the low point for the year. We are seeing major panic in the markets, and as you can see with the 10-year yield action on Tuesday, already a 40 basis point bounce higher from the lows of Monday.
My six-flags recession model has not indicated an incoming recession yet. Even though I see a path for two of the last three flags to go up in the next four to six months, these metrics will recover as soon as we defeat this virus.
In years to come, however, don’t be shocked to see 10-year yield go negative when the next recession hits.