Analyses
Where Are Bond Yields Going? It depends on what part of the curve you are asking about.
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Market Pulse
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mai 13, 2020
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mai 13, 2020
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Where Are Bond Yields Going? It depends on what part of the curve you are asking about.
Where Are Bond Yields Going? It depends on what part of the curve you are asking about. |
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Liquidity versus Solvency
The goal of the Fed’s policy response function is to prevent the liquidity crisis brought on by Covid-19 from becoming a solvency crisis. This is achieved by keeping interest rates low in the short- and intermediate-term segments of the yield curve, providing corporations with the opportunity to refinance debt at lower costs and have ongoing access to affordable capital. The ultimate goal is to minimize funding risks and keep companies solvent.
As such, the main focus of the Fed is to keep rates managed lower for maturities of less than 10 years. On the other hand, maturities greater than 10 years are at risk to rise and have their curves steepen.
Will the Fed succeed? Perhaps. Part of the answer relies on whether it can force the private sector to participate in the market. There is often some skepticism at the onset of Fed purchase programs and the risk that the private sector may not follow. But in that case we reiterate that the Fed will do “whatever it takes” to achieve their goals, and we do not think it wise to “fight the Fed” and end up on the wrong side of this trade.
In the end the impact of the Fed ultimately depends on the lingering impact of the coronavirus and the path and pace of the reopening of the global economy.
Supply and Demand: It’s all about the math
There is a massive amount of supply in the markets. The question is whether it can be effectively matched by demand.
Supply
The refunding of U.S. Treasuries (UST) was slightly larger than expected and skewed towards longer maturities:
- On the yield curve we saw a modest steepening for maturities less than 10 years and a more pronounced steepening for those greater than 10 year
- UST 2-10-year peaked at 265bps in 2013, bottomed at -5bps in Aug 2019 and are now starting to re-steepen at 54bps, a 20% retracement.
- UST 10-30-year peaked at 125bps in 2013, bottomed at 10bps in July 2018 and are now at 71bps, roughly a 50% retracement.
- The supply of corporate bonds is currently estimated at $1 - $1.5 trillion in 2020 (and we expect it closer to $1.5 trillion as we are already at $840 billion YTD). This compares to $1 trillion in 2019.1
- Negative interest rates? Fed Chair Powell says no! He stated in an interview with the Peterson Institute on May 13, 2020:
- The current Fed tools are working, and it does not see it necessary to move to negative rates.
- The Fed has seen mixed results on negative rates, no clear evidence that they work.
- The risk of using negative rates is that it impacts the bank intermediation process, i.e. it impedes its ability to extend credit to the real economy.
- We think that a move to negative interest rates would also mean serious structural and legal considerations, including a review of Dodd-Frank and prime and money market funds.
Demand
Demand is primarily a function of the Fed and their Quantitative Easing program. As of today, most of QE is focused on maturities of less than 10 years. Beyond that, the Fed has indicated they will keep policy rates at 0% for “as long as it takes,” perhaps until 2023.
- Mathematically this keeps front-end, and to a large degree, intermediate-term rates anchored.
- Longer-term rates tend to be less impacted by near-term policy expectations.
A note on credit risk
The Fed purchase program is designed to support Investment Grade debt, but not most of High Yield. As we like to say at MSIM, High Yield is “outside the tent” and will not benefit from the Fed’s monetary policies. In the end the Fed cannot eliminate credit risk, an important consideration for active managers.
Reopening global economies
The pace and the path of the reopening of global economies is a linchpin of the Fed’s market outlook
- When the economy opens, it is assumed it will it stay open. But will it?
- Does consumer confidence return? It is our view that this depends on medical developments, including therapeutics (a vaccine?) and improved preparedness of the healthcare system.
- A reopening of SMALL BUSINESS is absolutely critical, as small businesses account for roughly 65% of job creation. We recommend that investors pay attention to the NFIB small business confidence survey (released on the second Tuesday of each month at 6 AM EST). The survey is akin to the ISM or PMI, but for small businesses, and is the most underappreciated economic data point we receive each month.
1 Bloomberg, 2019
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 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 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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