Months ago, The Oxford Club’s Bond Strategist Steve McDonald told me he thought the interest rate on the 10-year U.S. Treasury was going to drop below 2.4%.

At the time, Treasurys were near 3% and the economy was improving.

I thought he was nuts.

Well, not only do I owe Steve an apology, I now agree with him.

In fact, I wouldn’t be shocked if the 10-year falls all the way to 2%.

[ad#Google Adsense 336×280-IA]Consider:

The economy was weaker in the first quarter.

GDP fell 1% in the first three months of the year.

No doubt the horrible winter impacted it some, but still, a 1% decline is just plain bad.

If the economy doesn’t rebound hard in the second quarter, then the economy’s improvement has ground to a halt and might even be going backward.

Also, consider that the Fed’s quantitative easing has been declining for months, yet interest rates have been falling steadily since the beginning of the year.

Tapering by the Fed should have put upward pressure on interest rates, yet they continue to fall.

That tells me the market has no confidence the economy is getting better, and I tend to listen to what the market tells me rather than a bunch of economists.

There are several countries in Europe whose 10-year bonds are trading below 2%.

Germany is at 1.36%, and France is at 1.77%. France! The place where they work about six months a year and had zero growth in the first quarter, after just 0.2% in the fourth quarter of last year.

And get this: The 10-year bond of the Spanish government yields 2.86%. Spain, with its 0.4% GDP growth in the first quarter and 26% unemployment rate, yields just four-tenths of a percentage point more than a bond backed by the full faith and credit of the U.S.

Something has got to give in the bond market. My guess is that U.S. Treasurys will strongly increase in price, which will push yields lower in order to get more in line with other countries.

The chart points to lower yields.

Take a look at this chart of the yield of the U.S. 10-year Treasury bond.

You can see from the chart there was support at both 2.6% and 2.5%, which didn’t hold. Since breaking below 2.5%, it has rebounded in the past few days. If it can’t stay above 2.6%, I suspect it falls all the way down to 2.0%.

What Does It Mean?

OK, so we’ve established that there are several reasons why the 10-year is likely to go lower. What will it mean for your portfolio?

Dividend stocks are likely to get even stronger. Stocks with a solid dividend have been on a heck of a run for several years as investors clamor for yield. Should bond prices and interest rates fall further, that will make the yields from dividend stocks that much more valuable.

You are likely to see a strong surge in dividend payers, which will push their yields lower. If you own dividend stocks, continue to hold. If you don’t, take a look at some quality companies that raise the dividend every year. Utilities should especially perform well as they borrow lots of money and are interest-rate sensitive. Plus, many of them pay 3% or 4% yields.

Bond prices will rise. Many people, myself included, have been saying bond prices will collapse when interest rates rise. The opposite is true if interest rates fall. So if you were thinking of selling some of your bonds, maybe wait to see if rates actually do head lower or if they stay above that 2.6% level.

If rates go lower, you’ll get a better price for any bonds you want to sell.

If you were thinking of buying bonds, now might be the time to do it before prices rise.

Keep in mind, I still believe interest rates will eventually move higher, but in the near term, I think 2% on the U.S. Treasury is more likely than 3%.

If rates do fall further, hopefully it will be the pick-me-up that the economy needs to get going. I never expected yields to fall this far nor to potentially drop back down to 2%. But I do now.

Steve, in a few months, I think we’ll look back and say you made a hell of a call.

Good investing,

Marc

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Source: Investment U