Treasury yields plunge, bond prices soar

Yields on Treasury securities plunged Wednesday as investors sought a safe haven from the stock market rout, and traders realized that the global economy is entering another slowdown.

The yield on the bellwether 10-year Treasury note fell as low as 1.873%, the lowest since May 2013, before settling at 2.13%. And the yield on the 30-year Treasury bond fell below 3%, to 2.92%. Other government bond yields plunged as well:

• — French 10-year government bond: 1.13%
• — German 10-year government bond: 0.75%
• — Japanese 10-year government bond: 0.48%

"Two percent looks sky-high compared to Germany," says John Lonski, Team Managing Director of the Economics Group at Moody's Analytics. "The bond market is finally pricing in the reality of indefinite subpar growth for aging advanced economies."

Why the bond rally? Investors look for safety from government bonds in times of crisis. And currently, investors fear losing money through falling prices — deflation — rather than through rising prices, or inflation.

The specter of deflation is haunting the markets. Oil prices have plunged to four-year lows on lower demand and bountiful production. The implied inflation rate for the next 30 years, based on 30-year Treasury Inflation Protected Securities, is just 2.09%. For the next 10 years, the implied inflation rate is 1.85%.

Even in China, one of the world's most rapidly growing economies, inflation is a low 1.6% — primarily because of stagnating wages. "Chinese wages are going nowhere," Lonski says.

And signs of slowdown in the U.S. point to deflation, not inflation. Despite rock-bottom mortgage rates, for example, the 52-week average of the Mortgage Bankers' index of home buyers' applications is at the lowest since March 1996, Lonski says. Baby Boomers, once a driving force in the economy, are spending less — partly because those who have lost their jobs in the past five years must settle for sharply lower wages. "They're going to get contract jobs and do the same work they did previously at lower wages," Lonski says.

The plunge in bond yields means that the Federal Reserve could delay raising rates until late in 2015 and could even be tempted to embark on another stimulus program. From the Fed's point of view, an outburst of inflation would be far easier to combat than widespread deflation.

The Fed can attack inflation by raising rates, but it has little room to push rates down further. "There are not a lot of bullets left if things get worse," says Bill Irving, portfolio manager of Fidelity Government Income fund.

The bonus for the worried: When bond yields fall, bond prices rise. For example, iShares' 20+ Year Treasury Bond ETF (ticker: TLT), soared 2.4% early Wednesday before settling at a 0.76% gain, says Morningstar. The 10-year T-note yield has fallen nearly a full percentage point since the end of 2013, when it yielded 3.03%. Investors in the iShares 20+ Year Treasury Bond have seen their shares soar 16.5% this year.

And, says Irving, mortgage rates are headed south again. Quicken Loans posted a 3.875% rate for 30-year fixed-rate mortgages, Irving notes, making this a good time to refinance a high-rate mortgage.