Bond Market Commentary
Bond Market Commentary
Bond Market annotations
By Doug Drabik
May 23, 2016
- U.S. domestic rates remain significantly higher than those of any other major economic power. Hong Kong’s 5-year rate of 0.939% is amid the closest to the U.S. rate of 1.37%. France, Sweden, Japan, Germany and the Netherlands are among the many nations with negative 5-year rates. Japan’s and Switzerland’s 10-year interest rates are also negative. No matter how well the U.S. economy does, global interest rates are pressuring the extent of any domestic move.
- Participation in the U.S. Treasury auction has seen a significant increase with indirect bidders (foreign bids). For example, late in 2012, indirect bidders accounted for roughly 25% of the 10-year auction. Recently, this number was 73.5% of the bids. Demand is high and foreign interest is helping to keep interest rates muted. What seems like low interest rates to many local investors is seen quite differently from a global perspective.
- The yield curve continues to flatten. One year ago, the 30-year to 1-year spread was 285 basis points (bp) and now is 202bp. The 2-year to 10-year spread was 166bp and is now 96bp, a 42% decline from 1 year ago. Central banks continue to attempt to influence the short-end of the curve. Three years and in, rates are higher versus 1 year ago, while rates beyond 3 years are all lower versus a year ago.
- Inflation has trended down since the financial crisis and the U.S. is not alone. Twelve of the G13 countries, which represent approximately 50% of the world’s GDP, have very low inflation rates, many of which are even lower the U.S. Consumer Price Index year over year of 1.13%.
- When you consider real rates or yields less inflation, the U.S. has actually faired quite well versus most economic powers. A majority of the curve and spread is captured within 12 years with corporate bonds and within 10-20 years with municipal bonds. The 3 factors which keep fixed income securities conservative remain: 1) predictable cash flows, 2) defined income stream (yield) and 3) stated maturities.
- Despite the significant higher yields, the U.S. central bank (Fed) continues to hint at raising interest rates either in June or now more likely in July. The June percent chance of a raise has moved to 32% while July’s has moved to 53.8%. This talk and Fed comments contributed this week’s yields being slightly higher from last Monday. Still, the 5-, 10- and 30-year Treasury rates are 38bp, 43bp and 39bp lower respectively on the year.
By Benjamin Streed, CFA
May 16, 2016
Summertime is just around the corner and oil is rebounding from its springtime lows, retail sales and the US consumer are showing signs of strength, wages are beginning to increase, job creation continues to grow at a decent clip and most other economic data appear to be both positive and relatively stable. So why then are we seeing headlines such as this one from Bloomberg, that proclaim “Yield Grab Pushes Treasuries Curve Near the Flattest since 2007”? Interestingly enough, although most economic data is reminiscent of a late stage recovery inflation continues to the proverbial “thorn in the flesh”, as it appears unable to breach the Fed’s intended 2% threshold or, at the very least, show meaningful signs of a rise consistent with the other positive economic data. As of Monday morning, the difference in yield between 2-year and 10-year Treasuries (blue line below) currently sits at only 95 basis points (bp) or 0.95% while the spread between 2-year and 30-year Treasuries (yellow line) rests at only 179bp. Both measures are at their lowest levels since the Great Recession and have shown a pretty consistent bias to the downside over the last few years in the post-quantitative easing (QE) world. The Federal Open Markets Committee (FOMC), informally referred to as “the Fed”, will meet next in June to add yet another chapter to the book of “will they or won’t they?” raise rates.
If the markets had to pick a single talking point, a key variable the world seems to be fixated on ahead of June’s Fed meeting it would be inflation. Stoking and maintaining a moderate level of inflation is not just an issue here in the US, but worldwide as most of the developed world struggles with the same challenge. For all the multi-trillion dollars, euros, and yen poured into the global financial system post-crisis it appears inflation is much harder to create this time around. How is this time different? Demographic changes have made the last crisis harder to deal with as a large portion of the global population enters their golden years. On top of that, central banks around the globe are more willing to do whatever it takes (think negative rates and QE) to help their domestic economies, despite the worldwide economy being more integrated than ever and likely warranting a more coordinated response. The markets are currently pricing in only a slight possibility of a rate hike in June and only a 50/50 chance anything happens by year’s end. However, inflation expectations are beginning to show some signs of life despite the flattening of the yield curve noted above. For example, the current 5-year breakeven rate, the difference in yield between a nominal 5-year Treasury note and a similar maturity inflation-linked note (TIPS) is 1.54%. This can be interpreted as meaning the market is expecting 1.54% inflation per year on average for the next five years. Seems low doesn’t it? The Fed would like to see something closer to 2.00%, but 1.54% is well above the post-recession low of only 0.94% seen back in February. In other words, 5-year inflation expectations are up 63% in only a few months. Where was the headline for that?
Hike? No hike? What difference does it make?
By Douglas Drabik
May 9, 2016
Several well-known market investors are saying not to count the Fed out for raising rates before year-end. Part of the rationale is Fed Chair Yellen’s focus on wages, which are moving up, as opposed to jobs and inflation being the triggers. At the same time, the curve probability for a rate hike has fallen below 50% for each of the 5 remaining FOMC meetings. As a matter of fact, the June probability is at just 4%.
One of these well know investors proclaimed the end of the bond rally back in March. The 3-year Treasury was 1.123% and 10-year Treasury was 1.933%. This morning, they were 0.865% and 1.769% respectively demonstrating that even the “best-of-the-best” have difficulty in accurately depicting interest rate moves.
Whether they are right or wrong would seem to have little significance. Since 2008, in the thrust of the financial crisis, the 10-year Treasury range is 4.27% in June, 2008 to 1.43% in July of 2012. Rates have failed to make any significant run higher since. In the last 4 years, the 10-year has stayed within 160bp range averaging 2.19%. If the Fed raises short-term rates, and if it impacts the intermediate and/or long-end of the curve and if it occurs before year’s end and if it is 25bp to 50bp and if most of the other economic indicators remain roughly the same or better, then so what anyway? Let’s just say that two 25bp hikes impact rates across the entire curve (a speculative rationale of its own) and the 10-year Treasury rate steps up from 1.73% to 2.23%. It would be back somewhere around the 5-year average of 2.21%.
The point is to spend less energy on the great unknown and more on what we do know. No one has convincingly predicted the future. It always gets back to knowing what you own and sticking with the plan. The investors who move money in-and-out of the asset classes and markets often wind up realizing actual losses and ill-timing market purchases, further pushing back long-term saving and wealth accumulation. Diversify asset classes appropriately and invest for the long-term sticking to your financial plan.
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.