The bond market is 'throwing a curve ball'

This could help settle one of the biggest debates in the bond market right now.

US Treasury yields have been falling as strong demand for Treasurys - a safe investment in volatile times - drove up bond prices. On Wednesday, the 10-year yield fell to a record low.

The drop in yields of various durations has flattened the curve that plots them. This flattening is sometimes used as an indicator of a recession.

So we should be worried about a recession, right? Wrong, according to Citi FX analyst Tom Fitzpatrick and team in a note on Thursday.

They wrote that when the yield curve inverted in 2006, the dominant view was that it was an anomaly, in part because the Fed was signaling higher rates. In other words, it was the opposite of what's happening right now.

Of course, the financial crisis proved that narrative wrong.

The economy looks a lot better now, but some in the bond market are once again missing the underlying reason for the yield curve flattening, according to Fitzpatrick.

From the note:

"Ironically, it is our belief that the misguided perception of reality in 2006 is exactly the reality of what is happening this time. Unlike 2006-2007 we see nothing in our "Techamental" charts that argues for elevated economic concern with regards to the US, quite the contrary. However, today's narrative is shaped, in our view, by the mistakes of 2007-2009 leading to the market (and the Fed) seeing every internal and external hiccup as the start of the next "crisis.""

What's really happening now is that US Treasurys are the strongest developed-market government bond that offers investors positive yield across all maturities.

Fitzpatrick again:

The whole US curve provides positive nominal (and further out real) yield. This, when the bond markets of Japan and Europe provide mostly negative nominal and aggressively negative real yields. Add to this the stubbornness of the Fed to continue to hold and reinvest the proceeds or a major chunk of the US bond market purchased during QE and you end up with a huge supply/demand imbalance.