The “yield curve” interest rates have (deservedly) received an outsized amount of attention in recent weeks.
This was particularly true in the second full week of August, when yields on most worldwide sovereign bonds slumped as investors clamored to buy them.
Bond prices and bond yields historically share a very strong inverse relationship, so as investors were bidding up bond prices last week, the yields on them were dropping sharply. One highlight from the flurry of activity was that the US 30-year Treasury bond yield dropped roughly 24 basis points during the week of August 12, which was its biggest weekly drop since 2013.
Investors and traders often retreat to bonds when perceptions over the strength of the global economy begin to weaken. The theory behind this behavior is underpinned by the expectation that sovereign governments are theoretically the last that would (likely) default on debt.
In turn, that also means that countries with historically strong economies tend to receive the greatest demand for their debt, and theoretically have yields that are at the lower end of the global spectrum. That reality matches the traditional investing axiom—lower risk equals lower return.
One wrinkle in the bond story last week relates to the U.S. yield curve. As a reminder, yield curves illustrate the various rates on government bonds going out in time.
A “normal” yield curve usually is represented through a gradually upward sloping line. Meaning as time to expiration increases, so too does the yield. Normal yield curves dictate that investors who tie up their money for longer periods of time are rewarded with a higher rate of return when compared to those who do so for shorter periods of time.
The opposite situation is known as an “inverted” yield curve. This occurs when short-term bond holders are rewarded to a greater degree than long-term holders. And last week, the U.S. yield curve (2-year and 10-year Treasuries) inverted for the first time since 2007. That meant that investors in 2-year paper would receive a higher rate of return for their investment than those tying up capital for 10-years.
Yield curve inversions often seize the attention of global markets because historical data illustrates quite clearly that the chance for a recession increases substantially in the wake of an inversion. Virtually every yield curve inversion in the last 50 years in the United States has been followed by a recession (although the time between the inversion and ultimate recession has varied widely).
And while the relationship between yield curve inversions and economic recessions has been widely reported recently, there’s some other data relating to bonds and yields that hasn’t been as widely circulated—especially as it relates to international markets.
Before looking at some of the highlights from the international bond market, it’s first worth reviewing how current U.S. yields compare to recent history, as illustrated in the chart below.
As the 10-year Treasury chart above shows, yields in the United Staes are already quite low when compared to recent history. However, U.S. yields take on a different luster when examined through the lens of the broader international debt market.
While U.S. yields may appear “low” by their own standard, a comparison to the international market—especially countries boasting strong economies—reveals that U.S. yields are actually on the higher end of the spectrum.
For example, consider that one of the other big headlines in the last two weeks was the fact that for the first time in history, every major bond in Germany (10-year, 20-year, and 30-year) was trading in negative territory at the same time.
That meant German bonds were in such high demand that the German government could theoretically borrow money from investors and get paid to do so. That information provides further context on U.S. yields; because there’s an argument to be made that while they are already very low, they could potentially drop even further.
One metric followed closely by international traders is the spread between German and US 10-year bonds. Given what’s already been covered in this post, it probably won’t come as much of a surprise to hear that this spread has moved toward the wider end of its historical range, especially with German bonds trading negative, and U.S. bonds still well above zero (at least for now).
Taking the difference between the US and German 10-year bonds can therefore provide further perspective on the relative value of each. As of now, that difference is roughly 2.36%, because as of now the US 10-year yield is trading about 1.58% while the German 10-year yield is trading roughly -0.78%.
Since 2000, the range in this metric has been between 0.80% and 2.80%. So in that regard, the current reading is up near the higher end of the historical range. Given that reality, it’s likely that bonds and rates traders are watching this spread closely for potential opportunities. If the US-German 10-year spread were to widen further, it’s likely that more than a few pairs traders would appear with the intention of betting on a reversal.
Given the heightened awareness around yields in the current trading environment, traders would be well-advised to keep abreast of changes in not only U.S. interest rates going forward, but also abroad.
For reference, the 10-year yields of several other countries that generally see strong demand for their sovereign debt are listed below:
- United States: 1.58%
- United Kingdom: 0.47%
- Japan: -0.23%
- Germany: -0.78%
- France: -0.41%
- Canada: 1.16%
- Netherlands: -0.54%
- Switzerland: -1.16%
- New Zealand: 1.07%
- Australia: 0.92%
- Spain: 0.08%
Traders seeking to learn more about the global interest rates and sovereign bond yields might want to review a recent episode of Futures Measures on the tastytrade financial network. The focus of this particular episode is “global interest rates.” Additional information is also available in the tastytrade LEARN CENTER.
Sage Anderson is a pseudonym. The contributor has an extensive background in trading equity derivatives and managing volatility-based portfolios as a former prop trading firm employee. The contributor is not an employee of luckbox, tastytrade or any affiliated companies. Readers can direct questions about any of the topics covered in this blog post, or any other trading-related subject, to email@example.com.