NEW YORK (CNNMoney.com) -- The last time the yield on the benchmark U.S. 10-year Treasury was below 3% was in April of last year, arguably the crescendo of investor fears about the state of the global economy.
Well, don't look now, but the yield on the 10-year is getting perilously close to 3% again. At one point Tuesday morning, it stood at around 3.15%, down from about 3.7% as recently as the beginning of May.
Investors have been busy buying U.S. Treasurys recently due to concerns about Europe and the potential impact the debt crisis there will have on global growth. (Bond yields fall when prices rise.)
Even though Europe's woes are likely to lead to some problems in the U.S., investors still generally view the dollar and bonds as safe havens. Hence, the strong demand despite the fact that few think the U.S. economy is a bastion of strength.
But how much longer can this last? Will investors continue to pile into Treasurys? The bond market faces a big test this week as the Treasury Department will be conducting a series of auctions. Most notably, $21 billion worth of 10-year notes will be up for grabs on Wednesday.
Quincy Krosby, chief market strategist with Prudential Financial in Newark, N.J., said she thinks there will be healthy demand for these Treasurys because investors are still worried about the global economic outlook.
"Once investors believe economic growth is showing meaningful traction, rates will head up. But until then, investors are more worried about the whiff of deflation than inflation," she said, adding that a 10-year yield below 3% is not out of the question.
"At this stage, nobody expected yields to be this low at this point," she said.
Still, some investors talk of a bond bubble. Concerns about Europe leading to another downturn in the U.S. may be overdone, which should lead to an eventual flight to the exits in the Treasury markets, and back to stocks and other riskier assets.
"There's an increased probability of a slowdown in growth. But Treasury yields are now priced to a level that's forecasting a double-dip recession. We still don't believe that's likely," said Tim Stringfellow, president of Frost Investment Advisors in San Antonio.
Stringfellow noted that the Federal Reserve is likely to keep short-term interest rates near zero for some time, and that could help prevent a double dip scenario.
But some argue that the Fed's interest rate policy, combined with a series of purchases of longer-term Treasurys, is precisely the reason why long-tem rates won't head higher anytime soon.
"Until the government gets out of the business of underwriting credit to keep rates low, yields will stay below 4%. In a truly free market, they could be closer to 5%. You'd expect yields to go higher, but it will take more time," said Subodh Kumar, a market strategist based in Toronto.
To be fair, several Fed officials have recently come out to suggest that the central bank will eventually need to raise rates in order to keep inflation pressures in check.
One of the most vocal Fed members in this so-called inflation hawk camp, Kansas City Fed president Thomas Hoenig, even went as far as to say that the Fed needs to raise rates to 1% by this summer.
If the market truly believed the economy was getting better, and that Fed chief Ben Bernanke was ready to put the brakes on inflation, long-term rates would probably have ticked up already. That clearly hasn't happened.
"The bond market didn't blink when the inflation hawks talked about raising rates. The 'extended period' for low rates is likely to be extended," said Steve Van Order, chief fixed income strategist with Calvert Funds in Bethesda, Md., referring to the term the Fed has used to describe how much longer it thinks rates should stay near zero.
So the Fed's in a pickle. If it keeps rates low, the bond market is likely to interpret that as a sign the central bank is still worried about how tenuous the recovery is.
But at some point, won't investors - especially big foreign holders of Treasurys such as China - grow impatient with the Fed and tire of having money parked in bonds that yield a little over a paltry 3%?
Prudential's Krosby pointed out that the fact that utility stocks have held up well as of late - the Dow Jones utilities average (DJU) was up Monday even as the broader market fell - could be a sign of investors looking elsewhere for steady income. Many utilities pay dividends that sport yields higher than the 10-year.
Still, as long as there are more doom-and-gloom headlines about turmoil in Europe and fears about the spillover effect on the U.S. economy, Van Order said anything's possible in the Treasury market. Rates could fall further even though yields are hardly attractive.
"On the one hand, you have to think, 'Do I really want to own a government bond yielding this little for that long?' Fundamentally, you'd think they are too low," Van Order said. "But the overseas jitters and bad employment report are keeping people in Treasurys."
- The opinions expressed in this commentary are solely those of Paul R. La Monica.
Find personalized rates:
BP trains up a small army of the unemployed to be ready on a moment's notice to clean oil from beaches in the Gulf. More
Lumber prices are tumbling, a possible sign of trouble for the nascent global economic recovery and U.S. housing rebound. More
Steve Jobs revealed the new iPhone, which is 24% thinner than the current model, has a better battery life, a higher resolution screen and an HD camera. More
BP trains up a small army of the unemployed to be ready on a moment's notice to clean oil from beaches in the Gulf. More
For parents with lousy credit, borrowing someone else's financial identity has become common, even if it belongs to their own child. More
Screen name (Select one with 3-12 characters; Numbers and letters only)
Enter your e-mail address below and we will send you an e-mail with a link and code to reset your password.
Already have the reset code?
Reset code
New password
Password
Forgot password?
Not a member yet?
Screen name
Password
Type what you see in the grey box
CNNMoney will use the information you submit in a manner consistent with our Privacy Policy. By clicking on "sign up" you agree with CNNMoney's Terms of Service and Privacy Policy and consent to the collection, storage and use of this information in the U.S. subject to U.S. laws and regulations. (learn more)
This service is temporarily unavailable. Please try again soon.
Thanks!
Please check your e-mail and click the link to confirm your membership. Then, you'll be ready to participate in all activities and conversations on our site.
Go to your Profile page
Read Full Article »