Rates and Gridlock

In the seven months since the election we have seen the 10-year Treasury yield move up to 2.6% in December, hit that level again in March, and we have since seen a steady decline to where we are today with the 10-year yield getting close the same yield level we saw the day after the election.1

As we wrote about at the beginning of the year (see our piece “Pricing Risk and Playing Defense”), our expectation was that we would see gridlock and delays in Trump getting anything passed—just as we are now seeing.  We also expected then, and continue to expect, that we won’t see much of a move in interest rates.  The lack of global demand and demographic trends are real and will have a lasting impact.  Inflation remains low and risks to growth persist in Europe, causing the ECB to continue with their quantitative easing when they met this past week.  In the US, Q1 GDP was the slowest in three years.  The population is aging and that will continue for decades to come, again, not favorable for demand growth of much other than maybe certain segments of healthcare.

When the Fed meets this week, we may see another rate increase.  However as we said back at the beginning of the year, if the Fed continues to raise rates, we would expect to see a flattening of the yield curve.

The equation is debt + demographics = no demand. We can talk about infrastructure spending, keeping jobs in America, and a reduction in corporate taxes, but we don’t see that as moving the needle enough to outweigh the continued drags from the debt burden and a demographic shift away from consumption of goods. What this means to us is that should the Fed pursue further rate hikes, we will likely see a flattening of the yield curve. We would expect that medium to long term interest rates will do nothing. (From “Pricing Risk and Playing Defense,” February 2017)

And that is just what we are starting to see, with the 2-year Treasury rate just at about where it was on March 13th, when we saw the recent high of 2.62% on the 10-year Treasury, but the 10-year rate is now down almost 50bps from the March 13th level.

We continue to expect that we won’t see much of a yield move in the longer-term Treasuries (5-Year Treasury rates and longer).  It is the 5-year and 10-year rates that are more relevant for us as high yield bond investors, as that is generally the issuing maturity range for high yield bonds and it is on those yields that spread levels are generally based.  While the Fed may well take a couple more rate increases over the year as they continue their slow move upward, we expect that to hit the shorter end of the curve more than the longer end.

As we close in on the half-way point for 2017, with our outlook for contained longer-term rates and unrelenting political gridlock, we continue to see selective opportunities in the high yield bond and loan space for active managers.  Investors need yield and a while we believe the broad high yield indexes and many index-based products tracking them are expensive at this point (just as many equity indexes and other asset classes are from our view), we do see specific opportunities for individual securities and, as an active manager, remain focused on capitalizing on these opportunities while still working to remain more defensive should volatility once again pick up as the political uncertainty and tempered economic growth continues.

1  Data sourced from US Department of Treasury, for the period 11/9/16 to 6/9/17.  https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield.
2  Data sourced from US Department of Treasury, based on the yields for 2 year through 30 year bonds for the dates 11/9/16, 3/13/17, and 6/8/17.


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