Rising Yields…What’s Next?
The following chart graphically compares treasury yields as of two separate dates (April 1, 2013-Yellow and December 09, 2013-Green). Each of the lines represent the “yield curve” on that date. A yield curve plots the interest rates of different bonds, with identical credit quality, over various maturity dates. The yield is displayed on the vertical axes and maturity on the horizontal.
Result: Over this time, you can see that there has been both a shift up in bonds yields with maturities over approximately three years and a steepening of the curve (particularly in the 3 year to 10 year portion).
What it means: The bond market seems to be reacting to two things, although both factors are intertwined. First, the economy continues to show evidence that it is improving. Second, a strong economy will allow the Fed to scale back, or “taper”, their aggressive buying of bonds (QE). Bonds, like stocks, trade daily and investors are always trying to stay in front of change. Therefore, the threat of a Fed Taper alone drives yields higher, before the change in Fed policy actually takes effect. It is not surprising to see a steepening on the intermediate portion of the curve. Fed Policy Makers have been outspoken on the Fed’s future actions. While a scaling back of buying bonds is imminent, new policy that would actually increase short-term rates isn’t expected for several years. This is helping to keep short-term rates nearly unchanged.
Going Forward: In the short-term, we anticipate some volatility in rates. Strong economic data, or Fed Taper commentary, should move rates higher, while any news (economic or otherwise) that would indicate a delay in current policy should bring rates lower. We expect more upward pressure on rates going into the 2nd Quarter to second half of 2014. Watch for higher mortgage rates and poor performance from traditional bonds. WE CONTINUE TO FAVOR STRATEGICALLY MANAGED BONDS over traditional bonds (buy hold). We believe that the risk/return tradeoffs of a buy-hold strategy on bonds (especially longer dated maturities) is unattractive at these levels yet do see opportunities within fixed income when certain risks are hedged, avoided and/or capitalized on (the very objective of strategic bond investing).