by Doug Drabik, Fixed Income, Raymond James
No wonder everybody’s confused! The Federal Reserve chair Janet Yellen commented last week on monetary policy and the headlines immediately read “Treasuries Fall as Yellen Speech Signals Fed Rate Boost in 2016”. The general message from her speech in Jackson Hole, Wyoming strengthened the case to raise rates because the U.S. economy is closer to the financial goals it needs to meet. So to clarify, Treasury yields ticked up as Treasury prices ticked down. We need to clarify because when interest rates go down, the headline usually reads something like, “Bond Yields Fall…” No matter what happens to interest rates, bonds seem to be staged in a negative light.
The irony in this lack of enthusiasm toward bonds is that bonds have upheld as the asset class of consistency. Bonds are the assets that have held up in this melee. What other asset class has accurately pinpointed the cash flow, the generated income AND the exact moment that the face value was or will be returned to the investor?
The overall feeling of confusion about rate direction is understandable. The truth is the Fed members are divided and with lack of consensus from within, the committee appears to have no idea what they are going to do. Domestic economic data releases are mixed. The global central banks maintain an “ease” monetary policy and are pumping money into the global markets. The disparity in global rates continues to pull money into the U.S. markets where interest rates are significantly higher than in other major foreign markets. Outside the psychological aspect of a Fed raise, 25bp will probably have little overall effect on the markets and do little to impact our own central bank’s accommodative stance.
Interestingly, U.S. Treasury yields have fallen to a point where the net yield (to foreign investors) is close to 0.00% after dollar hedging costs are implemented (basically insurance on potential losses that could occur when converting currency value differences between a foreign currency and the dollar). Thus the foreign draw to the U.S. markets is shifting to spread products such as corporate bonds. It is not surprising that over $200 billion in foreign money has infiltrated our markets. According to the Bank of America Corporate indexes, the weighted average U.S. investment-grade market is 2.76% with a duration of 7. By comparison, Europe’s weighted average investment-grade yield is 0.62% with a duration of 5. The gravitation toward U.S. debt is contributing to one of the more significant fixed income changes: a slow spread tightening in corporate bonds.
The net effect is that by direct and indirect means, market manipulation is occurring on both the short and long-end areas of the curve. As long as money continues to flow into the market, bonds get purchased by central banks and the disparity in global rates continue, the yield curve will likely keep on flattening and pressure will sustain this low interest rates environment. Therefore, domestic bond markets currently offer relative value for many investors. Despite the casted negative headlines, bonds remain the reliable and predictable portfolio cornerstone.
Copyright © Raymond James
