The US stock market has recovered since the pullback in late January and 30-year US Treasury bonds have rallied 50bp since the end of last year, but 10-year US Treasury yields are still down 40bp for the year, a situation that “defies easy explanation and most likely reflects a complex combination of circumstances,” writes Michael J. Hood, global markets strategist at J.P Morgan Asset Management.

sp500 v UST 10yr 0514 Treasury Yields

Treasury yields: Bearish sentiment doesn’t explain the discrepancy

The first explanation for soft 10-year bond yields might be that sentiment is turning bearish, but that doesn’t mesh with the rebound in equities and in other bond maturities. Five-year treasury yields have regained nearly all the ground lost in January and February, while 2-year Treasury yields are up for the year.

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Another explanation might be that tensions between Ukraine and Russia has caused inflows to US Treasuries, pushing down yields, but this can’t be the whole story either. If there were a general flight to safety you would expect USD, gold, and oil to get a similar boost, but gold has fallen since February, oil is roughly flat since the end of 2013, and the dollar is really only appreciating against the euro because of the ECB’s commitment to preventing deflation. There may be an indirect effect, where flows from Eastern Europe push down German Bunds, which in turn put a drag on Treasury yields by discouraging shorts.

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Finally, Hood believes that investors are recalibrating their expectations for equilibrium bond rates for a lower trend growth rate and more stable inflation expectations, but isn’t satisfied that any one explanation really captures what’s happening in the bond market.

Strange behavior not severe enough to change portfolio allocations: Hood

While strange, Hood explains that the overall impact is small. Implied volatility (measured by the MOVE index) is low by historical standards, and both the 2-10 and 10-30 curves remain quite steep despite recent flattening. Also, the 10-yr Treasury yield is still on track to move from 2% at the end of 2014 to 4% by the end of 2016 unless there is a more serious change.

“Given the favorable cyclical outlook, and considering that the equity risk premium has widened thus far in 2014, overweight positions in stock versus bonds, and modestly short positions in duration, still appear to represent warranted pillars for asset allocation,” writes Hood.

UST yield curves 0514 Treasury Yields