In Part 1, we wrote about three macro factors that will act to restrain economic growth through the rest of 2019 and into 2020. Those risks are the baked-in fiscal tightening, the lagged effects of monetary policy tightening, and growth retarding trade policy. Together, they could restrain growth to levels well below expectations and induce a profits recession at the least. At the worst, they could cause an economic growth recession if an appropriate policy response is lacking. In today’s report, we will address one of the asset allocation implications of those factors, namely that long-term US Treasury bonds could have a substantial downside in yield even from these levels.

As our readers know, the yield on a US Treasury bond is composed of inflation expectations, growth expectations, and a term premium. The term premium is the added yield investors require to compensate them in the case of unexpected rises in inflation or growth over the course of the bond’s life. Since last Fall the yield on the 10-year treasury bond has fallen from 3.23% to 2.16% as of this writing. The interesting thing about this substantial 1.07% drop in yield is that the entirety of the move is accounted for by the drop in inflation expectations (-43bps) and the drop in the term premium (-64bps). Growth expectations are exactly flat from where they were at the peak in rates last Fall.