Perspectivas
How to Read the Drop in U.S. Treasury Yields
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Market Pulse
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febrero 25, 2020
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How to Read the Drop in U.S. Treasury Yields
How to Read the Drop in U.S. Treasury Yields
How to Read the Drop in U.S. Treasury Yields |
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The 10-Year U.S. Treasury (UST) has reached new, historic lows in light of the widening Coronavirus outbreak. This is prompting questions by many people if the new, lower rate reflects lower growth expectations for the U.S. economy. The answer, of course, is yes. But there is more to the story.
I think we need to look at the move to lower UST yields in a few dimensions:
- Classical: Lower longer term yields tend to signal lower growth expectations. This makes sense, given that the risk of coronavirus-related economic slowing, especially in the service sector (a large part of U.S. GDP) is something that the UST 10-year yield decline is reflecting. This is the narrative dominating the market, but I think it tells only one-third of the story, the other two-thirds is technical.
- Technical: We must realize that global bond yields are very low, which presents a problem for hedging; it is that many developed market bond yields, like German Bunds or Japanese Government Bonds, may not be able to move materially lower. I mention this because from a hedging perspective the UST is probably the best candidate to buy and use as a hedge against riskier assets, simply because U.S. Treasury yields have the most scope to fall.
U.S. Treasury yields have plenty of room to fall in yield, and the Fed has plenty of scope to cut. Compare this with Bunds and the European Central Bank (ECB), for example, where the ECB has little room to cut, if at all, and Bund yields have less room to fall because they are already very low. Thus, all else being equal, an investor would prefer to buy USTs vs Bunds for hedging purposes. This adds to demand for USTs, and explains partially why yields are falling so much.
I think the technical is dominating the market behavior. Thus I don’t think the fall in yields is a one-for-one reflection for economic contraction in the U.S. But of course, some of the fall in yield can be attributed to lowered expectations for growth.
The next thing we need to look at is if spreads remain stable/low and keep pace with the drop in UST yields. I argue that with below 1.30% in UST 10-year yields that spread product will not keep up with the decline in UST yields, thus we get lower yields and wider spreads. This could lead to wider spread risk-off moves in the market.
Obviously, events are very fluid, and we will continue to be watchful as events unfold.
Risk Considerations
There is no assurance that a Portfolio 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 may therefore be less than what you paid for them. Accordingly, you can lose money investing in this Portfolio. Please be aware that this Portfolio may be subject to certain additional risks. 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. Mortgage- and asset-backed securities are sensitive to early prepayment risk and a higher risk of default, and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market and interest rate risks. Certain U.S. government securities purchased by the Strategy, such as those issued by Fannie Mae and Freddie Mac, are not backed by the full faith and credit of the U.S. It is possible that these issuers will not have the funds to meet their payment obligations in the future. High-yield securities (“junk bonds”) are lower-rated securities that may have a higher degree of credit and liquidity risk. Public bank loans are subject to liquidity risk and the credit risks of lower-rated securities. Foreign securities are subject to currency, political, economic and market risks. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed countries. Sovereign debt securities are subject to default risk. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, correlation and market risks. Restricted and illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk).
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Managing Director
Global Fixed Income Team
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