From October 2018 to September 2019, the yield on the 10-year Treasury fell from 3.25% to 1.48%. Over this period, the 2-year note declined from 2.9% to 1.3%. The major factor behind this drop was slowing global growth and fears that the trade war would hurtle the US economy into recession.
Short-term rates tend to reflect expectations surrounding monetary policy, while long-term rates reflect expectations around growth and inflation. At its nadir in September, the 10-year was close to its July 2016 lows, while the 2-year was more than a full basis point above its July 2016 low.
So far, the recession scenario has not materialized. Growth has slowed but remains positive. Weakness in manufacturing has been contained with no signs of a slowdown in critical areas like housing, labor, and consumption.
Fourth-quarter GDP is estimated to come in at 1% based on the Atlanta Federal Reserve's GDP NowCast. This level of growth and inflation is quite positive for stocks and bonds as it leads to a low-interest-rate environment without any adverse consequences such as high inflation or asset bubbles. This is clear from the last decade in which these conditions have persisted. It's also clear that these conditions are not optimal for remedying inequality or helping poor or middle-class people build wealth.
Trend Change or Oversold Bounce
In recent weeks, yields seem to have stabilized. The 2-year note bounced from a low of 1.39% to 1.68%. The 10-year note has climbed from 1.43% to 1.92%. The bounce in rates is positive as is the steepening of the yield curve. Both developments coincide with expectations that the economy will improve. There are several other bullish 'green shoots' such as progress in trade negotiations, improvement in leading indicators, and removal of disastrous tail-risk outcomes like a 'no-deal Brexit' or further escalations between the U.S. and China.
Stocks are already rallying as if the manufacturing sector has turned. Broad-based indices have broken out to new highs with the strongest gains concentrated in cyclical stocks. In effect, assets are beginning to price in an improving economy just like they priced in a near-recession a couple of months ago.
In a couple of months, economic data will either begin to ratify this optimism, or it will show this optimism to be foolish if there is no material development. In this case, expect asset prices to quickly give up these gains. In a sense, it's the inverse of what happened from October 2018 to September 2019.