Bond Market Commentary
Bond Market Commentary
Long-term planning versus short-term speculation
By Doug Drabik
October 24, 2016
As we near the last couple of months of the year, the loudest noise still echoes the Fed’s decision on whether they will hike short-term interest rates or leave them alone. Of course the Fed’s self-proclaimed mantra, their transparency, has been about as clear as mud. Based on the latest implied future probabilities, there is now a 67.6% chance that the Fed hikes interest rates in December, bypassing the November FOMC meeting which falls just days before the presidential election. When looking at where we stand, one starts to wonder if the most compelling reason for a hike at this point is just to prove that they can.
Over the last month, interest rates have shifted up but this move is still slight when stepping back and looking at the big picture. Interest rates are still lower than where we started the year.
Now take a look at where global interest rates are. Although some conjecture is circulating about certain central banks potentially slowing their accommodative positions, the European Central Bank, Bank of Japan and Bank of New England remain actively accommodative. The global trend in interest rates remains downward and projected activity for most reporting central banks through year-end also remains poised for rate cuts.
So why is this so significant? Although the US is not actively increasing its accommodative monetary position, we clearly remain in one. The US has reaped the benefits of having a growing, albeit slow growing, economy. It makes our interest rates very attractive on a global basis, pushes demand for US products, and thus, impacts pricing and net yields.
Much recent talk has been made about the ever increasing foreign interest in U.S. municipal bonds. The truth is that the curiosity is the story. The idea that foreign investors are considering a spread product held almost exclusively by US investors speaks to the world state of interest rates. For US investors, the tax-exempt benefits afford individuals an ideal buy-and-hold way to protect capital and collect tax-free interest. International investors may benefit from taxable municipals or Build America bonds.
According to the U.S. Department of the Treasury (as of June, 2015), foreign long-term security holdings were approximately $16.202 trillion of which $6.655 trillion is equities and $9.547 trillion is bonds. Foreign investors continue to hold heavy interest in US Treasury securities at about 46% or $6.196 trillion. Putting this in perspective, SIFMA reports that the US Outstanding Bond Market Debt for the same time period was $39.873 trillion, meaning foreign held US bond debt is approximately 24% of the total outstanding.
What this means for US individual investors is that there may be a strong case to suggest that interest rates may not rise significantly higher anytime soon based on global rates and global monetary policies. The foreign demand for US securities alone may keep interest rates in check. Again we circle around to the idea that fixed income is purchased by many investors for long-term planning and not short-term speculation. This is a very different mind-set that is required versus that for portfolio growth assets. As I repeat so often, fixed income assets, for the hold-to-maturity investor, lock in cash flow, income and a date where face value is returned. Keep core assets and mind-set separate from speculative and/or growth assets.
By Benjamin Streed, CFA
October 17, 2016
Over the last few weeks we’ve seen an uptick in volatility, helping push yields across the curve higher. Although there has been no real news or pinpoint catalyst for the sudden rise in yields, many in the markets point to a prevailing feeling that central banks are getting close to the end of their record stimulus. Although we’re clearly not there yet, markets are taking any indication from the major central banks, including the US Federal Reserve, European Central Bank (ECB), Bank of Japan (BOJ) as providing the proverbial “light at the end of the tunnel” for monetary stimulus in the post-recession era. Obviously, there’s still a very long way to go and it’s uncertain as to how close we really are to the end of the “unprecedented” stimulus regime we’ve seen since the Great Recession, but it does seems as if market sentiment is beginning to shift. Of course, as much as the markets have moved in the last month (see the chart below) it is always helpful to put current levels in context of where we’ve been historically. The 10y Treasury yield currently sits at ~1.80% having seen a sudden spike in yield from ~1.56% in late September, with 5y and 30y maturities seeing a similar pattern. However, we started the calendar year with a 5y yield of 1.76%, the 10y at 2.27% and the 30y bond at 3.01%.
We now find yields at their highest levels since June, before the summertime period in which some in the markets proclaimed volatility was “too low” and that yields were bound to head higher. Well, here we are in October and it seems to have played out exactly as this contingent had anticipated.
Meanwhile, inflation expectations are heading higher in the US as many take recent hawkish commentary from the Fed as an indication that the committee will raise rates for the second time in their December meeting. Additionally, some of the movement is the result of a mini “taper tantrum” brought on by the ECB when they hinted that if/when they decided to end their asset purchase program they would “taper” it down, even though they openly admitted they were likely to increase their stimulus in coming months. The market appears jittery and seemingly will hang on any and every hint of the end of monetary stimulus, even if it happens to be many months or years in the future.
Fed Chair Janet Yellen recently commented that they saw “plausible ways” that letting the US economy run hot, meaning above 2.00% inflation for a period of time, would help repair some of the damage done during the crisis. This comment, amongst others, sent markets back to work repricing the yield curve and pushing forward expectations for inflation higher. As always, it remains to be seen how this will all play out as the market has been known to get a little ahead of itself whenever sentiment from central bankers shifts even in the slightest. According to Bloomberg, the odds of a December rate hike stand at ~66%, close to the same level of certainty we saw ahead of last December’s hike. Stay tuned for more.
Back to normal
By Benjamin Streed, CFA
October 3, 2016
October begins with a volatile, but ultimately unchanged, month of September in the rearview mirror while many look ahead to the uncertainty surrounding the US presidential elections next month. Many had expected volatility to pick up at the end of the summertime, having seen both equity and bond market volatility hit multi-year lows beginning in June and culminating in late August. Although many expected an increase in volatility, September was choppier than nearly anyone had expected thanks in large part to global central banks overseas including both the European Central Bank (ECB) and the Bank of Japan (BOJ) in addition to the US Federal Reserve (Fed). The playbook went something like this (see the chart below): the ECB met on September 8th and indicated that they would refrain from further easing, pushing yields across the world sharply higher. This led many to speculate that the BOJ and Fed would follow suit and also turn more “hawkish” (in favor of tightening monetary policy), including a possible rate hike here in the US. For the next two weeks markets would continue to be volatile, pushing equities lower (bottom chart, green line) and yields higher (purple). The volatility for bonds (top chart, yellow) followed equity volatility lower (blue) as most markets could’ve been described as “sleepy”. Shortly after the Fed confirmed it would remain on hold the markets returned to “business as usual” with lower volatility, higher equity prices and lower yields. If you ever needed convincing that the markets are heavily influenced by the central banks this was the proof.
Although the Fed was on hold, it was a very different tone this time around as the hawkish sentiment was blatantly obvious with three “nay” votes, the first time this has happened since December of 2014, with the first hiking coming in 2015. One of the sticking points for the Fed is that it wants to see inflation closer to 2.00% before a second hike is justified. Interestingly, the committee doesn’t see that level being reached until 2018 and have also decreased their GDP growth estimate to 1.80% from 2.00%. For reference, the post-crisis GDP estimate has steadily declined from 2.65% to the current 1.80%. Fed Chair Yellen noted that, “we are generally pleased with how the US economy is doing”, despite their estimates consistently being revised downward and/or stretched further out. For now, it appears the “hawkish hold” is one that continues to encourage data dependency and will be patient in both the timing and frequency of any future rate hikes. Of course, with the election slated for November, many are expecting any move from the Fed to be in December at the earliest with an approximately 59% chance of a rate hike according to Bloomberg estimates. September came, September went and seemingly not a whole lot changed overall.
Meanwhile, although the Treasury market continues to garner strong focus from both investment professionals and the media, it would be apt to remind readers how the credit markets are faring. US domestic corporate credit continues its strong performance with impressive year-to-date gains, more than making up for September’s back-and-forth. For those interested in seeing more details broken down by industry, credit rating and maturity you can see our Weekly Index Monitor here. Spreads are roughly in line month over month and remain significantly lower than their levels from a year ago. Much of the performance in bonds is attributed to the duration effect (longer-dated bonds have outperformed shorter-dated) with the remainder due to the decline in overall credit spreads.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.