What Is Happening to US 'Safe Assets' - Part 1: US Treasuries

The background of rising Treasury yields and flattening yield curves rarely leads to good economic outcomes. We show, in this report, that the currently flat US yield curve reflects poor domestic liquidity conditions. This, in turn, is leading investors to move deeper into already expensive ‘safe’ assets, and the resulting skewed distribution of term premia warns of slowing US economic activity over the next 6-12 months. We argue that the skewness of the distribution of term premia is far better at predicting future economic slowdown than the flatness of the yield curve slope. Slower economic activity should ultimately cap the rise in bond yields. We continue to see 3.5% yields on 10-year Treasuries tested this year, but with the growing odds of a bond rally thereafter. The FOMC project seven policy rate rises to end-2020: we foresee, at most, three, largely because US liquidity is already very tight. Fed Funds may reach 2½% and stop.