Why it's too soon to call the end of treasuries' bull run

Risk assets have got off to a good start this year but strategists are sceptical about calling time on treasuries' bull run.

While more bullish investors have shrugged off warnings about the strength of the recovery from the likes of the International Monetary Fund and think tank Niesr, bears are refusing to let go of the idea that the eurozone could still implode and growth grind to a halt.

If the latter scenario prevails 10-year treasury yields could fall as low as 1%, according to some.

Capital Economics argues that while the first month of the year brought with it more positive data than some had dared hope, the global recovery will ultimately disappoint.  Because of this it is the consultancy's base cast that benchmark 10-year Tips will could fall significantly from their current 1.9% level, and hover at around a 1.5% average for the foreseeable future as transient positives die away.

Julian Jessop, Capital's chief global economist, says evidence of this scenario  has started to emerge.  'The recent rebound in economic data have been flattened by some temporary positives that are set to fade away, including the unwinding of supply shocks due to last year's natural disasters, and perhaps a temporary burst in demand from corporate and household spending,' he said.

What's more, there are also some negatives  set to increase over the course of this year, with fiscal policy tightening in key economies the risks of a hard landing in China.  At the forefront of these negatives is the eurozone, where Jessop believes the worst of the crisis  has still to unfold.

Even if Greece can avoid a disorderly default, Jessop's' scenario can still play out and will bring with it a boost in demand for safe havens as well as a further fall in treasury yields.  Adding to this are concerns about China, where its economy remains poorly balanced, with excess investment and a teetering property sector, both of which suggest the risks to growth lie firmly on the downside and add to safe havens' allure.

Jessop also points to America's monetary policy as a key catalyst for a drop in yields.  US monetary policy is set to stay super-accommodative, but he also believes that additional easing may not be needed for yields to be driven down.

'As it happens, the focus of QE3 may well be on additional purchases of mortgage-backed securities rather than of government bonds. But treasury yields actually increased in the wake of both QE1 and QE2, as risk appetite recovered and inflation expectations rose,' Jessop explained. 

'Our forecast that Treasury yields have further to fall is based on a downbeat view of global economic prospects, the likelihood of a renewed surge in safe haven demand as fears of euro-zone break-up grow, and a prolonged period of near-zero short-term US interest rates. Even if the US economy holds up relatively well – something which we have already factored into our forecasts – these pressures should still drag Treasury yields down.'