New York CNN Business  — 

Investors are so nervous about the trade war with China that they are frantically scooping up US government bonds and pushing yields sharply lower in the process.

The 10-year US Treasury yield dipped to 1.75% Monday — its lowest level since October 2016. Yields fall as demand for bonds increases and prices rise. It’s a sign of growing investor anxiety about where the global economy is headed.

Although the Federal Reserve has only cut interest rates once (by a quarter of a percentage point) so far this year, the yield on the 10-year has fallen nearly a full percentage point. The 10-year bond started 2019 with a yield of around 2.7%.

It’s a classic case of investors flocking to safe assets even though the returns may be puny or, in some cases, negative. The 10-year yields for German and French bonds have been below zero for a few weeks. The German 30-year bond went negative on Monday. Dutch bonds joined the negative yield club too. And the rate for the British 10-Year bond fell to its lowest level ever, now yielding just 0.5%.

Yields are falling fast

Investors were rushing to bonds as stocks plunged following the escalation of the trade war between the United States and China after China’s currency fell below an important psychological level.

Yields could go even lower, despite the fact that it seems crazy to buy a bond that pays little (if any) interest.

Conservative investors are worried about a possible liquidity crisis and it’s better to own safer government bonds than speculative stocks. If you’re saving for retirement or other long-term goals, preserving capital is more important than generating huge returns.

“Why on Earth are investors buying Treasuries and European bonds with negative yields? It’s because you want to hold the safest asset you can find,” said Brendan Mulhern, global strategist with Newton Investment Management.

“People are forced to buy low risk assets for liquidity needs because there is a perception that liquidity is deteriorating,” Mulhern added.

No end in sight to US-China trade spat

Conditions could get a lot worse before they get any better.

China said Monday it would stop buying US agricultural imports. And President Trump tweeted that China was engaging in “currency manipulation” and appeared to urge Fed chair Jerome Powell to cut rates further.

“Are you listening Federal Reserve? This is a major violation which will greatly weaken China over time!” Trump said.

So Powell may need to slash short-term rates more quickly — not necessarily because of pressure from Trump but because the bond market is screaming for more rate cuts. If the Fed waits too long, the global economy could grind to a halt just as it did in Japan decades ago due to a persistent lack of inflation.

“I don’t think the Fed is paying too much attention to the president’s Twitter account, but Fed members are paying attention to what’s happened in Japan the past 30 years and Europe more recently,” said Scott Ladner, chief investment officer at Horizon Investments, referring to fears that a lack of inflation could limit growth around the world.

“The Fed needs to act more forcibly and try to prevent things before they happen,” Ladner added. “We know what an economic black hole looks like. It’s Japan. And that’s a scary place for central bankers.”

But the Fed — and other central banks for that matter — may not be able to do much to keep bond yields from plunging further if the Trump and Xi administrations are intent on one-upping each other in the trade war. Nobody wants to be the first that blinks.

“This return of trade uncertainty is unlikely to be solved quickly. So there will be be bouts of increased stress in the bond markets,” said Matt Toms, chief investment officer of fixed Income at Voya Investment Management.

New lows likely for the US 10-Year

Toms added that it doesn’t help to have fears of a messy Brexit returning to the forefront now that Boris Johnson has taken over as the UK’s Prime Minister.

Newton’s Mulhern thinks it’s possible that the US 10-Year could get back to all-time lows of below 1.4% from the summer of 2016, especially if the Fed continues to cut rates over the next few months, a move that now seems more likely despite what Powell said last week.

And he added that it’s impossible to know how much further into negative territory European bond yields could plummet.

“Honestly, I don’t know what the limit is in Europe,” Mulhern said.