Just a few short months ago, it was unthinkable. A year ago, it was beyond the pale. But the extraordinary arrived yesterday when the 10-year Treasury yield fell to lows previously unseen.
The 10-year closed on Tuesday at 2.69%, a record low. The embedded message is clear: the market expects deflation, or something close to it. In the rush to find a safe haven, investors are bidding up the prices of government bonds to extreme levels. In turn, yields are falling to depths few thought possible.
The primary source of this outlook is, of course, the weak economy. “The big picture background for these very, very low Treasury rates is the weakest economy we’ve seen in at least a generation,” Jay Mueller, senior portfolio manager at Wells Capital Management, tells BusinessWeek. “We’re looking at a severe recession and the Treasury markets are reflecting that kind of an outlook.”
The favored policy response for deflation is cheap money, and the Federal Reserve is moving heaven and earth to engineer just that. Indeed, the effective Fed fund rate is roughly 0.5%. But that invites the challenges that come with the so-called zero bound.