U.S. Treasury Yields
Foreign investors buy our Treasuries, which in turn pushes our interest rates lower. To do that, they sell their own country’s currency to purchase U.S. dollars, which strengthens our dollar.

This week I have been paying particular attention to our Treasury market.

The 10-year Treasury note recently fell below the 1.70 percent level and seems to be headed still lower. This is happening for several interesting reasons. One cause is the future direction of Fed interest rate policy. But a big factor is the global arbitrage opportunities that central banks around the world are creating.

To get a closer look, let’s first take a trip to Europe.

In Germany, the two-year bonds (aka bunds) cost approximately -0.55 percent and the 10-year pays +0.02 percent. Buying Germany’s two-year note means you are paying the German government for the right to hold the bond. You are losing money. For the 10-year, you are essentially getting no return on your money.

Traveling to Japan, we find the two-year bond costs -0.28 percent, and the 10-year costs -0.16 percent. So you get nothing in return for investing in Japan.

By comparison, the two-year U.S. bond pays +0.75 percent, and the 10-year pays +1.65 percent.

So let’s think about this: An investor gets nearly 75 bps more to invest in a two-year U.S. Treasury than in a German 10-year bund. Why would investors in Europe want to buy a bond for the next 10 years and essentially get no return? Most would look for another opportunity, and they are finding them here in the United States.

Foreign investors buy our Treasuries, which in turn pushes our interest rates lower. To do that, they sell their own country’s currency to purchase U.S. dollars, which strengthens our dollar.

There is nothing wrong with this, of course. These investors are taking advantage of the arbitrage opportunities central banks from around the world are creating. In a low-rate world, investors will scramble to wherever they can find the best yield with the lowest risk. That leads them to our U.S. Treasury market.

As we have said before, the Fed could take advantage of this demand and raise rates here in the United States. Almost any rate hike created would eventually be erased by the market. Foreign buyers would continue to purchase our bonds, driving rates lower still.

Again, I don’t think the Fed should raise rates—and I happen to believe that they will not raise rates. However, if they do, this is probably the best time to do so from a market perspective. From an economic one, that is an entirely different story, which is why I do not think it happens.

Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.