Italian political crisis adds to allure of U.S. 10-year notes, relative value also sends yields lower.
Up until around the third week of May, investors may have been questioning whether 3.00%-plus yields on the 10-year Treasury note would be the norm in the coming weeks and months.
But thanks to a confluence of factors, driven mainly in recent days by a political crisis in Italy, U.S. Treasury notes and bonds are once again being viewed as the safe bet for investors seeking refuge from the storm.
The political crisis in Italy may have fanned the flames of what had already been a move back in to U.S. Treasury after the benchmark 10-year Treasury note hit a yield of 3.11% on May 17, signaling perhaps that it was well on its way to even higher levels. Since then, though, the yield on the 10-year note has declined to just under 2.80% as of May 29.
Yields have fallen most recently after Italy President Sergio Mattarella blocked on May 27 the formation of a coalition government comprised of the 5 Star Movement and League parties. That raised the potential for new elections and potential momentum over concerns for Italian debt (which is among the highest of developed nations) and the country’s commitment to the euro.
Stock, bond and currency markets have been broadly repricing risk in the wake of the political upheaval in Italy. In the U.S., the Dow Jones Industrial Average fell 1.6% on May 29 compared to its previous close, while the S&P 500 index declined by 1.2%.
A shift back to the 10-year note had already been underway prior to the turmoil in Italy as interest rate investors were enticed by the 10-year note’s relative value compared to bonds of other developed countries, namely Germany. Prior to the 10-year note hitting 3.11% the gap between its yield and that of 10-year German government bonds (known as bunds) had been near its highest level since 1989.
Impact of Lower Yields?
The direction of 10-year Treasury notes matters to sectors of the stock market which may tend to ebb and flow with the movements in interest rates. This is generally the case with sectors like utilities and real estate, which are often seen as proxies for bonds given that they tend to pay large dividends compared to other sectors of the market.
The snap back in 10-year Treasury yields may be good news for consumers looking to buy a home. During the week ending May 24, 30-year fixed mortgage rates reached 4.66%, their highest level since early May 2011, according to Freddie Mac’s Primary Mortgage Market Survey. Thus far in 2018, mortgage rates have had the most sustained increase to start the year in over 40 years – rising in 15 out of the first 21 weeks of the year.
A lower 10-year Treasury yield, which directly impacts mortgage rates, could provide some respite to borrowing costs for buyers looking to purchase in a housing market where prices are trending upward, while available and affordable inventory is declining. See the real estate section of the BCJ Insights Monthly Economic Update: May 2018 for more on the U.S. housing market.
Lower yields could also benefit other housing, mortgage and interest-rate sensitive stocks like home builders. Through May 29, the S&P 500 Homebuilders Select Industry Index is up by 1.3% since the 10-year Treasury note closed at 3.11% on May 17.
And though the degree of correlation between swings up or down in interest rates and the performance of real estate investment trusts (REITs) is a complex one (you can read about it here), the sector has gotten a boost from the recent dip in 10-year notes. The S&P/Citigroup U.S. REIT Index is up 3.5% through May 29 from May 17.
Not faring as well from the recent turmoil in Italy and the flight-to-safety in U.S. Treasurys was the banking sector. The KBW Bank Index, an index developed by Keefe, Bruyette and Woods which tracks 24 banking stocks that include large U.S. national money centers, regional banks and thrift institutions, has been declining since 10-year notes topped out at 3.11%. The index is down 5.7% since May 17 and fell 3.9% on May 29 compared to the previous session’s close, partly due to concerns over global banks’ exposures to European sovereign debt, including Italian government bonds.
Sources for market data:
10-Year Treasury Note
Dow Jones Industrial Average
S&P Homebuilders Select Industry Index
S&P/Citigroup U.S. REIT Index
KBW Bank Index
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