Tight Grip

Published on Jan. 23, 2018

Tight Grip

What’s in the News:

The extended hunt for yield that began after the 2008-2009 financial crisis continues to exert extraordinary pressures on fixed income yields, pricings, and the interdependence between credit markets. Demand for investment grade assets to produce the highest possible current income has led to a persistent flattening of the US Treasury yield curve, while yield spreads between US Treasury and US corporate issues continue to tighten.

Just two years ago, the US Treasury 2-year note traded at 1.05% yield to maturity, while the US Treasury 10-year note traded at 2.27% yield to maturity. At the conclusion of 2017, the same two issues were priced at 1.88% and 2.41%, respectively. While the Federal Reserve’s tightening monetary policies have effectively increased short-term interest rates, nearly doubling the market yield on the 2-year note, the 10-year note has barely budged.

Put another way, the US Treasury 2-10 year yield curve has flattened from 123 basis points (1.23%) at the end of 2015 to just 53 basis points (0.53%) at the end of 2017.

US Treasury 2-10 year yield curve
Source: Bloomberg

For conservative income-oriented investors, the compression of yields available from investment grade corporate bonds over the same time has been even more pronounced. The 2-10 year yield curve of the domestic corporate bond market has collapsed to 113 basis points (1.13%) – nearly half of the 207 basis points (2.07%) steepness that existed along this yield curve two years ago – dramatically reducing the availability of potential current income levels.

2-10 year yield curve of the domestic corporate bond market
Source: Bloomberg

What are we thinking?

There are many explanations for such dramatic movements along these yield curves, but the bottom line is one and the same: investors have been steadily offered less income incentive to extend the maturities of their investments while simultaneously being left to assume more credit risk to obtain the same returns available to them two years prior.

As pressures on fixed income investing have changed the market environment, innovations in the bond market are increasingly tailored to meet the demands of both lenders and borrowers to address the challenges of transitioning from a historically low interest rate environment to a potentially more normal landscape. One of these developments has been the growing issuance of fixed-to-floating rate preferred securities, which we incorporate into CIP’s allocation to preferred securities.

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