Bond Market Rally: Historic Low Treasury Yields and Plunging Oil Prices
On March 9, 2020, 11 years to the day from the bottom of the Financial Crisis in 2009, yields on treasury bonds went lower than they’ve ever gone in our nation’s history. By the close of business on the 9th, 10-Year treasuries were yielding 0.56%, and 30-Year treasuries were yielding 0.99%. These are unheard-of levels.
Imagine loaning the government money for 30 years, in exchange for a 1% return. It’s important to remember that bond yields move inversely to bond prices, so dropping yields mean higher prices for the bonds. A popular ETF that tracks the price movement of 20-Year Treasuries, TLT, was up 26.83% year to date on March 9, illustrating the incredible demand for Treasury bonds during this current stock market madness.
As I write this on March 19, 2020, the yields have normalized to some degree, and the TLT is now only up by 6.88%. In case you’re trying to do the math in your head, if you bought TLT on the 9th, you’ve lost 15.73% on your money in ten days in Treasury bonds! So what is causing all the madness? COVID-19 is affecting this, but the recent price war over oil is causing just as much madness as the virus.
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Bonds, COVID-19, and Oil
Saudi Arabia and Russia both have decided that they are going to sell as much oil as they can, at hugely discounted prices, for who knows how long, to try and gain market share and potentially put the shale and fracking companies in the U.S. out of business. Because of those decisions, the price of oil fell by 60% from January 1, 2020, to March 18, 2020, dropping from $63.27 a barrel to a low on the 18th of $20.06 intraday.
The markets, stock, and bond alike are currently pricing in a worst-case scenario for both the COVID-19 outbreak and the oil price wars and racing each other to find the bottom.
Financial Relief Packages
The fears around COVID-19 are the economic disruption likely to occur will be more significant and longer than most people expect. The markets are pricing in considerable reductions in earnings for companies almost across the board. And they have yet to consider the impact of the vast financial relief packages being processed by the federal government as we speak. In days, not weeks or months, an untold amount of cash will begin hitting the financial system. The total cannot be known yet, but my best guess is in the multiple trillion-dollar ranges.
The U.S. will throw the entirety of its financial might at containing and eliminating the threat from COVID-19. Make no mistake about it. If we learned anything in the financial crisis and the recovery years that followed it’s this; don’t fight the fed. The money that is going to be injected into the financial system, which is almost certainly going to involve the federal reserve purchasing stocks, will re-inflate asset values. It may not happen overnight, but it will happen.
The fears over the oil price war are that the bonds that hold the debt of the fracking and shale oil companies will become worthless because the assumption is that they can’t survive for long with oil prices below $50 a barrel. As mentioned above, the price of oil is currently closer to $20 than $50. Though the oil producers have proven that they can withstand that kind of price pressure for far longer than the market assumes they can, the worries over the debt are not unfounded, if for no other reason than the sheer amount of money that is involved. There are somewhere between $700 billion and $1 trillion of debt by the shale oil and fracking companies held by banks and other lending institutions. So, if the default worries come to pass, you can see the kind of impact that would have on the financial system.
Saudi Arabia & Russia
I know that Saudi Arabia, and probably Russia as well, are feeling like their backs are against a wall as they are almost 100% dependent on the sale of oil and gas to support their economies and massive social programs. The emergence of the U.S., as the largest producer of oil and gas and as a net exporter of the same, has removed the monopoly those countries used to have in the energy industry. They can no longer drive prices higher by artificially creating supply shortages, and they have lost market share to the U.S. at the same time. The only tool they have is to drive prices so low that the U.S. producers throw in the towel and stop producing oil and gas. I don’t think that’s going to happen. Only time will tell.
Oil and gas may stay artificially low for a while longer, even without Saudi and Russian price cuts, as the market is pricing in a considerable drop in demand for them on top of the price war. We’ve seen relatively dramatic reductions in travel, on a global scale, due to the fight to contain the COVID-19 virus. These reductions are a good idea, but they’re horrible for the economies of the world, notably those economies that are dependent on energy production or tourism as their primary sources of revenue.
Bond Market Rally: In Conclusion
Once things begin to normalize, and the COVID-19 fears are in our collective rearview mirror, oil prices will normalize as well. And by normal, I mean +/- $50 a barrel. If you own energy stocks, and you’re waiting for the time when oil is 100 a barrel again, you’re going to be waiting a long, long, long time.
In closing, I want to urge you to be of good cheer. You are starring in a made-for-television movie that will be released in 2030.
Trying as they may be, these are historic times. Not everyone gets to live through events that changed the world, but you are!
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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.