By Sam Goldfarb and Gunjan Banerji
The yield on the benchmark 10-year U.S. Treasury note fell below 1% for the first time Tuesday, a stark measure of investors' rising anxiety over the likely economic impact of the coronavirus outbreak.
After an upbeat start to 2020, markets have done an abrupt about-face on the likely impact of the new coronavirus. The Dow industrials were down as much as 997 points at midafternoon Tuesday, on track for their eighth loss in nine trading sessions. The latest declines came after the Federal Reserve moved sooner than expected to cut interest rates, citing the likelihood that the virus outbreak will slow global growth in coming periods.
Stock prices often rise as yields fall following a Fed rate cut, reflecting expectations that lower borrowing costs will boost economic growth. But traders said Monday's 5% rise in the Dow industrials made traders less apt to step in to buy on the Fed move, while questions about the extent of coronavirus-related economic damage remain open.
Declines in stock indexes and bond yields Tuesday were "strictly about fear," said Donald Ellenberger, senior portfolio manager at Federated Investors.
After falling as low as 0.914%, the 10-year Treasury yield settled at 1.005%, according to Tradeweb -- still down from 1.085% at the close Monday. The decline extended a remarkable 2020 bond-price rally in a market that is by some measures the central cog in financial markets, helping to determine borrowing costs for consumers, businesses, and state and local governments. Bond prices rise when yields fall.
The rapid fall in Treasury yields this year has caught many traders off guard, fueling hedging activity and forcing investors that had bet against the government-bond rally to close out their positions, analysts said, giving even greater fuel to the price upswing. At the start of 2020, the record closing low was 1.365%, set in 2016. Yields topped 3% as recently as late 2018.
Traders who expected rates to rise "were caught offside," said Arthur Bass, a managing director at Wedbush Securities. "The move happened a lot quicker and a lot further than they thought."
The 2020 bond rally extends a decadeslong shift in the U.S. and global economies toward slower, steadier growth and lower inflation. The decline in bond yields has been fueled in part by demographic shifts and changes in consumer preferences or savings rates.
But the 10-year yield also is widely watched on Wall Street as a sort of fear gauge, with falling yields often -- though not always -- pointing to acute concerns about the health of the economy. Investors tend to snap up government bonds at times of stress, and the coronavirus has stressed markets in recent weeks more than any event in years.
"Right now, it's just simply panic buying," said Mr. Ellenberger of Federated Investors.
Bond yields started the U.S. trading session sightly above levels from Monday but took a sharp turn downward shortly after the Fed announced it was cutting its key policy rate by half a percentage point -- its first between-meeting move since the financial crisis.
The move in yields mirrored the one in stocks, which fell shortly after the Fed's announcement and extended declines after Fed Chairman Jerome Powell acknowledged the limits of the central bank's actions in a news conference.
Many investors and analysts had expected yields to bounce from their lows at the end of last year as the outlook on the economy brightened. Government bonds and stocks concurrently notched huge gains in 2019 and investors predicted that their lockstep moves would diverge.
Instead, fears about global growth led investors to keep pouring money into Treasurys, causing the 10-year yield to fall to record lows last week.
Fear isn't the only factor in the Treasury rally this year: Institutions such as banks turn to interest-rate derivatives to hedge their exposure to bank deposits or mortgages, which can change rapidly as borrowing rates fall. Banks looking to hedge could fuel as much as $400 billion in Treasury buying, according to JPMorgan Chase & Co. estimates.
"It causes the market to systematically trade somewhat differently from expectations. You're going to rally more than expectations would suggest, " said Josh Younger, head of U.S. interest-rate derivatives strategy at JPMorgan, of the technical factors.
Some investors may have been caught wrong-footed by the Treasury rally, giving it even more steam. Leveraged funds such as hedge funds have been betting that Treasury prices would fall and yields would rise, Commodity Futures Trading Commission data show. There were roughly three bearish bets for every bullish one on 10-year Treasury futures in January and February, the data show. These bearish bets would profit if yields rose and bond prices fell. Investors may have had to hedge as yields dove instead, analysts said.
There were other factors at play, too. Liquidity -- or how easy or difficult it is to buy or sell -- fell for benchmark Treasurys in February, according to JPMorgan. Poor liquidity can exacerbate market swings both up and down.
"That just means the price impact is much higher. If you're trying to buy an equivalent amount of stuff, it's going to impact the price more than it would've two weeks ago," said Mr. Younger.
Write to Sam Goldfarb at email@example.com and Gunjan Banerji at Gunjan.Banerji@wsj.com