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August 05, 2021

Is Low US Government Issuance Depressing US 10-Year Yields?

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August 05, 2021

Is Low US Government Issuance Depressing US 10-Year Yields?


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Is Low US Government Issuance Depressing US 10-Year Yields?

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August 05, 2021

 
 

Markets were spooked mid-month as the Delta variant of COVID-19 surged across many parts of the globe. This made for a choppy period, but markets regained composure before month-end. The S&P 500 still managed to reach an all-time high in the second half and had a positive return of 2.4% (USD) . The US outperformed Europe, with the EuroStoxx 50 returning 0.8% (EUR)1.

 
 

Despite Olympic hosts Japan doing well in the medals table, the same cannot be said for its market with the Nikkei 225 down -5.2% (JPY)1, almost flat YTD. However, the worst performer of major markets this month was China. Having already underperformed relatively throughout 2021, this month’s market rout pushed the MSCI China Index (USD) down -13.8%1. US-China relations deteriorated and China asserted a regulatory crackdown, which included Chinese technology, as well as private tuition companies. The VIX remains low at 18.22 and only reached 22.22 during the mid-month jitters2.

The path forward for US rates

The US 10-year Treasury yield continued its move down from a seemingly low 1.5%3 at the end of June, to 1.2%1 as of 31 July 2021. This is counter-intuitive because last month’s Federal Reserve dot plot for 2023 to now, includes two rate hikes. Furthermore, in July the Federal Open Market Committee (FOMC) continued to suggest the Fed is moving towards announcing tapering plans, probably in late 2021.4

One explanation for the drop in yields is the normal seasonal decline in July/August US Treasury issuance. In addition, this year the US Treasury has benefitted from having raised substantial funds last year, not all of which have been spent, further reducing required issuance now. By maintaining bond purchases at the same level whilst issuance is down, the Fed is temporarily easing monetary policy. This puts significant downward pressure on yields. Once issuance and therefore the supply shortage eases, we expect rates to resume their move up. Importantly, however, the shortage of US debt may be exacerbated in the near-term by the debt ceiling that came into effect on 1 August, which limits total US debt issuance to its aggregate level as of 31 July 2021. It is extremely likely that the debt ceiling will be raised. Until then, US debt issuance is likely to be subdued and rates may struggle to rise in the face of continued Fed bond buying.

The start of a new capex cycle?

We are seeing an increase in capex that we expect will continue. Both the CEO Confidence Survey5 in the US (lead Q4) and the Euro Area Business Climate Indicator (lead Q1)6 are up. A vigorous capex cycle in this low interest rate environment, could have a significant multiplier effect, driving up hitherto stagnant economic productivity and economic growth. Moreover, a capex increase has typically led to a pick up in loan demand. Banks could decide to finance these loans by pulling reserves currently sitting idly in central bank accounts and lending these out to the real economy. This is likely to raise the “velocity of money” with concomitant upward pressure on both inflation and interest rates.

Investment Implications

We continue to be constructive with respect to global growth. Given the recent low volatility environment, we have been fine-tuning our portfolios by raising equities slightly, to ensure that our portfolios remain in line with their respective volatility targets. That said, amidst consensus optimism, we are considering how long the low volatility environment is likely to persist. As discussed in our last outlook, we are keeping a keen eye on any catalysts. These range from inflation to anti-trust policy, US-China tensions to virus variants, any of which may upend the current low volatility and trigger a spike.

In July, from a tactical stand point, we trimmed Financials and below we describe the rationale for this change:

Financials

We remain overweight Financials and have been since November 2020, in keeping with our cyclicals theme and tilt to value. However, we trimmed our position in July to take some profit. We implemented the position last November, in anticipation of a synchronised return of global growth, with banks amongst the highest sector beta of earnings to global GDP growth. At the time, valuations were also depressed in absolute terms. However, now the sector appears to be slightly expensive.

Tactical positioning

We have provided our latest tactical views below:

 
 
 

Source: MSIM GBaR team, as of 31 July 2021. For informational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The tactical views expressed above are a broad reflection of our team’s views and implementations, expressed for client communication purposes. The information herein does not contend to address the financial objectives, situation, or specific needs of any individual investor.

 
 

The index performance is provided for illustrative purposes only and is not meant to depict the performance of a specific investment. Past performance is no guarantee of future results.  See Disclosure section for index definitions.

1 Bloomberg, 1-month return, 31 July 2021.

2 Bloomberg, 31 July 2021. The VIX© reached 22.5, 19 July 2021.

3 Bloomberg, 30 June 2021.

4 Federal Reserve issues FOMC statement. Press Release. 28 July 2021. 
www.federalreserve.gov/newsevents/pressreleases/monetary20210728a.htm

5 US Bureau of Economic Analysis (BEA), Conference Board, data as of 9 July 2021. 

6 European Central Bank (ECB), Macrobond, data as of 9 July 2021.


 
 

RISK CONSIDERATIONS

There is no assurance that the Strategy will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them.  Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events.  Accordingly, you can lose money investing in this portfolio. Please be aware that this strategy may be subject to certain additional risks. There is the risk that the Adviser’s asset allocation methodology and assumptions regarding the Underlying Portfolios may be incorrect in light of actual market conditions and the Portfolio may not achieve its investment objective. Share prices also tend to be volatile and there is a significant possibility of loss. The portfolio’s investments in commodity-linked notes involve substantial risks, including risk of loss of a significant portion of their principal value. In addition to commodity risk, they may be subject to additional special risks, such as risk of loss of interest and principal, lack of secondary market and risk of greater volatility, that do not affect traditional equity and debt securities. Currency fluctuations could erase investment gains or add to investment losses. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. Equity and foreign securities are generally more volatile than fixed income securities and are subject to currency, political, economic and market risks. Equity values fluctuate in response to activities specific to a company. Stocks of small-capitalization companies carry special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed markets.  Exchange traded funds (ETFs) shares have many of the same risks as direct investments in common stocks or bonds and their market value will fluctuate as the value of the underlying index does. By investing in exchange traded funds ETFs and other Investment Funds, the portfolio absorbs both its own expenses and those of the ETFs and Investment Funds it invests in. Supply and demand for ETFs and Investment Funds may not be correlated to that of the underlying securities. Derivative instruments can be illiquid, may disproportionately increase losses and may have a potentially large negative impact on the portfolio’s performance. A currency forward is a hedging tool that does not involve any upfront payment. The use of leverage may increase volatility in the Portfolio.

 
andrew.harmstone
Managing Director
Global Balanced Risk Control Team
 
manfred.hui
Managing Director
Global Balanced Risk Control Team
 

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INDEX DEFINITIONS

The indexes shown in this report are not meant to depict the performance of any specific investment, and the indexes shown do not include any expenses, fees or sales charges, which would lower performance. The indexes shown are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

Capex: Capital expenditure – the funds a company expends on purchasing, upgrading or maintaining fixed assets such as property, plant, equipment.

Dot plot:  This is a “forecast” released by the Federal Reserve on the projected fed funds rate. It is based on a voting system with each member of the Federal Open Market Committee (FOMC) determining their own projection of where the fed funds rate should be at the end of each year. These are collated into the dot plot, which presents the distribution of “votes” for each year end between the members, with the market looking at the median forecasted level of rates at every year end.

Euro STOXX 50 Index: Provides a blue-chip representation of supersector leaders in the Eurozone.

GDP Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in a specific time period. It includes all private and public consumption, government outlays, investments and net exports.

MSCI China Index: This free-float adjusted capitalization-weighted index is designed to measure the performance of China-based equities.

Nikkei 225 Index: This price-weighted index is comprised of Japan's top 225 blue-chip companies on the Tokyo Stock Exchange.

S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.

VIX®: This is a trademarked ticker symbol for the Chicago Board Options Exchange Market Volatility Index, a popular measure of the implied volatility of S&P 500 Index options. Often referred to as the fear index or the fear gauge, it represents one measure of the market’s expectation of stock market volatility over the next 30-day period.

DISCLOSURES

The views and opinions are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all portfolio managers at Morgan Stanley Investment Management (MSIM) or the views of the firm as a whole, and may not be reflected in all the strategies and products that the Firm offers.

Forecasts and/or estimates provided herein are subject to change and may not actually come to pass. Information regarding expected market returns and market outlooks is based on the research, analysis and opinions of the authors. These conclusions are speculative in nature, may not come to pass and are not intended to predict the future performance of any specific Morgan Stanley Investment Management product.

Except as otherwise indicated, the views and opinions expressed herein are those of the portfolio management team, are based on matters as they exist as of the date of preparation and not as of any future date, and will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date hereof.

Certain information herein is based on data obtained from third party sources believed to be reliable. However, we have not verified this information, and we make no representations whatsoever as to its accuracy or completeness.

The information herein is a general communications which is not impartial and has been prepared solely for information and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy.  The material contained herein has not been based on a consideration of any individual client circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

Past performance is no guarantee of future results. Charts and graphs provided herein are for illustrative purposes only.

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