How To Profit From the Treasury Yield Drop

History also tells us that the bond market tends to be "right" a lot earlier than the stock market. Therefore, the enormous decline in the U.S. 10-year Treasury yield that has taken place since late-April (from 4.7% to 3.7%) has been very telling.

The question now is what it’s telling us. Has inflation come down in a serious way and will continue to drift lower, or is the economy going to slow down in a substantial manner?

Here’s what it means – and the one asset class this is really good news for.

Recently, I’ve been arguing that a decline below the key support level of 3.8% for the 10yr note would be a signal that economic growth is going to slow in a more meaningful way than most economists are thinking right now.

History tells us that when long-term rates decline somewhat, it doesn't tell us a whole lot about the economy. However, when those yields drop in a major way, like they have over the past six months, it usually indicates a material slowdown in growth. In fact, it usually signals that a recession is coming in the not-too-distant future.

I cannot claim to know whether the recent drop below the key support level of 3.8% means we're headed for a recession, but it is a very good indicator that the slowdown in growth over the rest of this year, and next year, will be at least in-line with what the consensus is looking for right now. Since slower economic growth means lower earnings growth, this particular drop in yields is not very bullish for stocks.

However, it is very bullish for bonds. Therefore, last week's meaningful break below 3.8% is a very good development for fixed income investors. As you can also see from the chart below, the change in trend for the 2-year Treasury note is even more compelling:

Having said all this, the 10yr yield (and the 2yr note) is approaching an oversold level. Therefore, it should see a bounce in yields at some point in the coming days or weeks. Even so, last week's meaningful break below 3.8% was an important development on the technical side of things. Unless any upcoming bounce is a very strong and consistent one, it's going to be very bullish for fixed income investors over the rest of this year (and likely into next year).

No market moves in a straight line, but bond yields sure look like they're headed for another leg lower, and thus bond prices are very likely headed for another leg higher!

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