Why Treasury Yields Are Falling

On Wednesday, the 10-year treasury yield closed below 3 percent for the first time since December.

By SHARE

The end of the Federal Reserve's highly controversial second round of quantitative easing, or "QE2," was supposed to bring about higher interest rates. But on Wednesday, the yield on the 10-year treasury bond closed below 3 percent for the first time since December 2010. Just a few months ago, the 10-year yield was near 4 percent. Here are three reasons treasury yields are falling:

Sovereign debt concerns in Europe. Multiple countries in Europe, most notably Greece, appear to be on the verge of default. After downgrading Greece less than a month ago, Moody's Investors Service cut the country's rating by several notches on Wednesday. Moody's noted that countries at Greece's current level have historically had a roughly 50-50 chance of defaulting on their debt. While Greece's economy is small in relative terms, the effects of a default are unknown. "There is an enormous amount of uncertainty of what [a default by Greece] means in terms of risk to the European banks and what may spill over to U.S. banks," says Madeline Schnapp, director of macroeconomic research at TrimTabs Investment Research.

[See 50 Best Funds for the Everyday Investor.]

When investors get nervous, they generally flock to historically safe investments like U.S. treasuries. "Despite the fact that we've got problems over here, the U.S. currency is still the best global currency there is," Schnapp says.

[See 5 Ominous Signs for Stock Investors.]

Bad economic news. A rash of disappointing economic reports, including a confirmation of a double-dip in housing prices as measured by the S&P/Case-Shiller index, have raised concerns that the U.S. economy is experiencing a slowdown or "soft patch." Add to that a sharp drop in the latest Institute for Supply Management (ISM) manufacturing index survey and a disappointing Automatic Data Processing (ADP) private employment report. These indicators have led to concerns that the recovery is slowing, which translates to more investors buying treasuries, says Ray Humphrey, a portfolio manager at Hartford Investment Management. "So long as you've got weakness in the economy, the buyers will emerge, and that's exactly how it's playing out," he says.

[See 6 Numbers Every Investor Should Follow.]

The end of QE2. The Fed's QE2 program—in which the Fed is buying up $600 billion worth of treasury securities to help jumpstart economic growth—ends this month. When a big buyer like the Fed exits the bond market, interest rates should rise because investor demand for treasuries drops. But for the time being, demand for treasuries is still strong because of concerns that the recovery can't stand on its own without support from the Fed. "The market is saying that we're going back to where we were prior to QE2 and asking the question, 'Does that mean we get a QE3?'" Humphrey says.

Twitter: @benbaden