Tuesday, April 13, 2021
Growth and inflation expectations are widely known fundamental variables used in determining fair value for fixed income securities, but are there seasonal patterns that exist in the bond market that can help investors determine when to allocate to fixed income? It would appear so. Most investors are aware that seasonal patterns exist in equities but they may not be as familiar with the seasonal patterns in fixed income markets. There are a number of ways to measure seasonality, but since the story this year has largely been about the change in the 10-year Treasury yield, we look at historical yield changes by month to answer the seasonality question.
“Despite what has historically been a good seasonal period for fixed income investors, we believe the expected upcoming good news on the economy will continue to push yields higher,” opined LPL Financial Chief Market Strategist Ryan Detrick.
As seen in the LPL Chart of the Day, some months appear more or less favorable to 10-year Treasury yield changes and thus 10-year Treasury bond prices. Each vertical bar represents the historical range of Treasury yield changes during each month of the year (omitting outliers in both directions). The orange dash represents the 30-year average change in Treasury yields. Dashes below the 0.00 line indicate falling yields (rising bond prices) and dashes above the line 0.00 indicate rising yields (falling bond prices). January, at least historically, has been one of the best months for 10-year Treasuries as yields on average have decreased. The next three months, however, have historically been fairly negative for bond prices. The most bullish months for 10-year Treasuries have historically been the May through September months before a challenging October to end the year.
In our opinion, there are a couple of possible explanations for the seasonality in the data. First, short-term borrowing needs for the U.S. government tend to increase during the first part of the year due to tax season, which generally increases the supply of Treasury securities. This increased supply could cause yields to rise. Second, because of the seasonal patterns in the equity markets, changing investor risk sentiment towards the middle of the year could make Treasury securities more attractive because they tend to represent a higher yielding alternative than cash. Finally, reversing the trend into fixed income from equities could likely explain the October challenges as investors rebalance out of fixed income and back into equities.
While the data suggests that now could be a good time to start adding interest rate risk to portfolios, in our view, the historical seasonal patterns are unlikely to hold this year. Growth and inflation expectations continue to trend higher, which puts downward pressures on Treasury prices. The next few months could be challenging for fixed income investors as the economic data is likely to show further sustained progress towards recovering from the pandemic. We expect yields to continue to move higher throughout the rest of the year to a range of 1.75% – 2.0%. Eventually it will make sense to add interest rate risk to portfolios, but we’re not there yet.
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All index and market data from FactSet and MarketWatch.
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