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Tricky Treasuries

What's in the News...

With five interest rate hikes since the end of 2015, the expectation has been for a much higher 10 year Treasury yield. Yet while the Fed controls the short end of the curve, supply and demand move the longer end of the curve. With this in mind, Informa financial intelligence Chief Macro Strategist David Ader argues that two things will hinder a dramatic rise in bond yields: the increasing Federal budget deficit, forecasted to hit $1 trillion in 2020, and the dynamics of fixed income indexing. As a result, he believes the rise in yields may in fact soon be at a peak.

Ader argues that according to the law of supply and demand, more supply warrants lower prices. That should lead to higher yields, but as a major federal budget deficit prompts additional Treasury issuance, he believes this will induce forced buying on the part of indices, which will in turn inhibit a dramatic rise in bond yields. 

Currently, US Treasuries make up 37.8% of iShares Core U.S. Aggregate Bond ETF. As more Treasuries are issued in the market, he says, they will also enter fixed income indices – and as they are purchased by investors to keep pace with changes in the index, this will ultimately send prices higher. It is these higher prices that could keep a lid on bond yields.

At the same time, Ader also considers how “not only will [investors] be forced to buy, but what they buy likely will be longer maturities”. He notes that “over the course of the recovery, the average maturity of outstanding Treasury debt has increased dramatically—to a near record 70 months, from less than 50 months in 2008”. Just as the Treasury market has gotten longer, the index’s Treasury allocation has as well. In this way, bond investors may be less subjected to the Federal Reserve raising rates if the mechanisms in place keep a lid on yields. 


What are we thinking?

Many are asking the question whether it’s time to get back into the bond market. In general, we believe that market participation should be based on your long term goals, risk tolerance, and other personal variables.

Designed to provide high income without taking excessive risk in a low rate environment, as well as benefit from a rising rate environment, our Current Income Portfolio is a suitable solution for investors seeking a risk conscious approach to income generation. As active managers, we seek to provide value by remaining cognizant of current trends, making reasonable and informed expectations of Fed announcements, paying attention to credit spreads, and diversifying in preparation for interest rates to trend higher. 



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