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Bond Yields Fall to Record Lows: Is It Time to Go Defensive?

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Bond yields at record lows

Bond yields continued to fall to record lows this week amid growing anxiety about a global economic slowdown. The US benchmark ten-year Treasury yield fell to 1.95% yesterday—close to its multiyear lows. So far, the ten-year Treasury yield has fallen more than 27% this year. In addition to US debt, European government bond yields have also reached record lows this week. The yield on the benchmark ten-year German bund fell to -0.398% on Thursday. The falling yields indicate that there’s a greater demand for safer investment options like government bonds. Bond prices and yields move inversely.

Recently, the US long-term Treasury yields continued to fall faster than the short-term yields. The yield on the three-month Treasury bill was close to 2.20% on Thursday, which moved the spread against ten-year yields to the highest levels this year. The inverted yield curve is usually considered to be a precursor of an impending recession.

Defensives look strong

Defensive sectors like utilities and consumer staples have already been rallying this year. The Consumer Staples ETF (XLP) and the Utilities ETF (XLU) have risen 18% and 15%, respectively. Investors shift to defensive sectors amid broader market turmoil largely due to their relatively low correlation to business cycles. These defensives generally have higher dividend payment capacities. Top utility stocks Southern Company (SO) and American Water Works (AWK) have exhibited an unusual rally this year. They have risen more than 30% each year-to-date. Southern Company and American Water Works form ~10% in XLU.

No concrete solution on trade relations

Even though trade war tensions somewhat eased after President Trump and President Jinping agreed not to levy any new tariffs last week, any definite solution to the trade disputes could take a long time. On Monday, anxiety about the global economic slowdown increased after the US threatened to impose tariffs on more Eurozone goods, which added to the woes.

The S&P 500 recorded its best first half in years after a strong rally last month. Currently, the S&P 500 is trading at its all-time high. The S&P 500 is trading in the overbought zone with its relative strength index at 80. According to the CME FedWatch tool, traders are expecting a 100% likelihood of at least a quarter-point rate cut this month. Barclays expects broader markets to continue rallying given the truce between China and the US last week. Barclays expects markets to increase if the Fed cuts rates and the economic slowdown doesn’t last long.

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