Written by Jeffrey B. Hibbeler
The steepening of the U.S. Treasury yield curve that has been taking place over the last several months picked up from gradual, to more rapid over the previous trading days. The 10-year benchmark has risen ~45bps in February and is at 1.50% as I write. Almost 1/3 of the move came in today’s (2/26/21) trade.
As with everything, there are several catalysts. Stronger data is one – two recent examples are retail sales coming in very strong last week and durables posting another impressive increase this morning. The prospect of another huge stimulus package is another, with the retail sales data showing that people will spend at least some of the government checks, increasing estimates for GDP already projected to be the highest in a few decades. Global yields have been rising; UK 10-year Gilts are up ~50bps this month and German 10-year Bunds up ~30bps. This is looking forward to a more normal, vaccinated economic landscape. Market technicals are contributing, with mortgage convexity selling likely causing some of the rapid intra-day moves.
Fed speakers have been out in droves this week and have not pushed back on the rise in yields. The party line has been that it is a healthy thing and shows the economy is recovering. Three different speakers have said as much. What is notable is the move in real yields, with 10 years up to ~-0.60%; these had been below -1% mid-month. Another notable move was the rise in 5-year yields, to 81bps currently. Some of this was driven by a poor 7-year auction which added to today’s (2/26/21) selloff, but the rise in 5-year yields is also starting to price in the likelihood of an earlier Fed hike due to the improving growth outlook. TIPS break evens contracted somewhat, although liquidity and other factors can affect their movement.
It is notable that the ECB has been pushing back in speeches this week about the rise in European yields. It of course has not come to that point yet for the Fed, but if financial conditions significantly deteriorate, they will begin to do so as well, and will take policy action if warranted in their view. They still feel they are a long way from their maximum employment and inflation mandates and intend on maintaining highly accommodative conditions to close these gaps.
There are several things we are doing to help mitigate these effects on portfolios. One is a corporate focus, which spread tightening (so far this year) and the additional yield earned somewhat offsets the effect of higher Treasury yields. Our portfolio target durations are shorter than they historically have been, in a 4–5-year range, generally leaning closer to a 4. We have been holding more cash than typical in most accounts and have been patient investing it, looking for good opportunities in which to invest. As those opportunities present themselves, we will and have used the dry powder to take advantage of them. Finally, in our laddered approach, as bonds periodically mature and income accumulates, we can reinvest at higher yields than we have seen in recent months.
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