Grannis Farley

Bond Market Commentary

A Return to Normal or Overly Exuberant Expectations?

By Drew O’Neil
November 12, 2019

What a difference a month can make. Since the start of October, the yield curve has seen quite a shift both in terms of shape and yield levels. An inverted curve a month ago has turned into a “normal” curve (long-term yields higher than short-term yields). Short-term yields have fallen while long term yields have increased. The slope of the curve has increased substantially regardless of which two points on the yield curve you are inclined to use to calculate the slope. The 3-month to 10-year spread has moved from negative 13 basis points (inverted) to positive 38 basis points, a 51 basis point swing. Similarly, the 2-year to 10-year spread increased from 9 to 26 basis points and the 1-year to 30-year increased from 39 to 83 basis points.

This somewhat dramatic shift over a relatively short timeframe appears to be due to a combination of factors. The short end of the curve has likely been pushed lower due to two factors. One, the FOMC lowered the Fed Funds rate by 25 basis points on October 30th, which has the obvious effect of pulling short-term yields lower. Second, in an effort to stabilize short-term funding and repo markets, the Federal Reserve announced that they would be purchasing T-bills in order to increase reserve levels and provide liquidity. As can be clearly seen in the graph and chart below, the effect has been a move lower for yields on the short end of the curve.

In addition to the action on the short end, the intermediate and long parts of the curve have been on the move as well, albeit in the opposite direction. As opposed to the movement in short-term yields which has been caused by a few definable drivers, the move higher by the rest of the curve appears to be mostly due to general optimism surrounding a potential USA/China trade deal and roll back of current tariffs. The hope is that this will fuel both the domestic and global economies to continue growing. This increases future expectations for both growth and inflation, which has led to a “risk-on” mentality that has investors selling Treasuries (pulling prices lower and pushing yields higher) and moving into riskier assets. November 7th provides a microcosm of the past month or so, as it was being reported that a trade deal was close and would include a rollback of current tariffs. We saw the 10-year Treasury move from 1.80% early in the day, all the way up to a peak of 1.97% that afternoon.

Whether yields will continue in this direction, or even remain at these levels, is still very much up for debate. While the move higher appears to be driven by mostly hope about the future, the actual data that has been coming out has been subdued. A reversal in the sentiment surrounding a US-China trade deal could send yields lower (potentially very quickly). The actual fundamentals both here in the United States and around the globe point to yields potentially remaining “lower for longer”, as we have written about recently. As we know, the global economy and geopolitical climate is constantly evolving, so what is true today may not be true tomorrow. Whether the current fundamentals win out or the hope for the future turns into reality is anyone’s guess at this point. What we do know is that for the time being, we have “un-inverted” and returned to a normally shaped (and higher yielding) Treasury curve. Depending on portfolio goals and your outlook for the future, now could be an opportune time to lock in the highest yields we have seen in the past several months.


To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.

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.