Tuesday, February 23, 2021
Treasury yields started moving sharply higher this past month (remember that as yields go up, prices go down). And while the upward march began in earnest last August when the 10-Year Treasury yield bottomed at an all-time low rate of 0.50% based on closing prices, the past week we saw the 10-year break through the 1.25% threshold and touch 1.35%, a new high for the year. So naturally, investors are right to ask two questions: 1) How does this recent move up in yields compare to previous recoveries and 2) what should be expected for the rest of the year?
“We believe more good news on the economy will continue to push yields higher, but there are also forces in play that may help slow the pace down.” said LPL Financial Chief Market Strategist Ryan Detrick.
How does this recovery compare to previous recoveries?
The LPL Chart of the Day outlines the yield movements during the recoveries after the last four recessions. Using the 1982, 1991, 2001 and 2009 recovery periods, we can see that we are in the middle of the increase in rates based on trading days. One thing that is unusual about the current recovery is that the rise in rates has happened later than in previous recoveries. In three of the four recoveries, yields peaked around 100 trading days into the recovery, while in 2021 rates have risen roughly a month later. The outlier recovery is 1982, which was delayed further by around 50 days. Back then, the increase in rates occurred, certainly because of increased growth and inflation expectations, but also because of the prospects of increased fiscal spending (remember the bond vigilantes?). While that sounds familiar to our current situation, we aren’t expecting those brave bond managers to eschew Treasury securities in the name of fiscal discipline.
What are we expecting for the rest of the year?
Our base case is that rates will continue to rise due to increasing growth and inflation expectations and, eventually, Federal Reserve (Fed) normalization. We believe yields will continue to move higher throughout the year with an upward projection of 1.75% (our year-end range for the 10-year remains 1.25% to 1.75%). We also believe if rates move too high too fast, the Fed will intervene to make sure rising rates don’t become too restrictive and disrupt equity markets or the real economy (Fed Chair Powell’s testimony to Congress this week is important here). A number of consumer loans are influenced by the levels of the U.S. bond market, most notably mortgage rates. A more interesting question, at least to us, is not where rates will be at the end of the year but how quickly rates rise from here.
Additionally, during recent LPL manager research calls with fixed income managers we’ve heard that asset managers (most notably pension and insurance funds) will get more interested in US Treasuries around the 1.50% level. It seems now those brave bond managers are likely to keep rates from rising faster than in years past, since there aren’t many other positive yielding options in this yield starved world awash with savings.
So it seems there are opposing forces pushing against each other to determine the appropriate level of rates. On the one hand, growth and inflation expectations are pushing yields higher, while the prospects of potential Fed intervention and increased savings demands due to aging demographics (both U.S. and non-U.S. savers) may help keep rates contained. We’ll continue to watch how this dynamic unfolds and see who ultimately wins this tug-of-war. Who says fixed income markets are boring?
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