By Megan Horneman. © Verdence Capital Advisors
- Treasury yields have been decreasing since March despite solid growth
- Bond investors are concerned about the threat of COVID variant related lockdowns
- Indication that some inflation may be transitory
- Fear the Fed will prematurely remove accommodative policy
- Lower supply but a lot of liquidity
Rapid economic recovery, inflation pressures, and acceleration in vaccines caused bond yields to rise and the yield curve to steepen the broadest level in six years. However, what we have seen in bond yields in 2Q has left investors and analysts confused. It is difficult to understand why long-term yields remain low, but here are five factors we believe are temporarily keeping yields depressed.
- Variant Fears: Bond investors are becoming more concerned about renewed lockdowns because of different COVID variants. The city of Los Angeles has again reverted to a mask mandate and countries like South Africa, Australia and Indonesia have reinstated lockdowns. Consequently, investors are questioning the safety of Treasuries if lockdowns threaten growth.
- Inflation peaking?: We will likely be paying higher prices until we repair supply disruptions and catch up with pent-up demand. Used cars have been one of the most significant contributors to recent inflation. However, lumber prices, which are an inflation indicator, give hope that relief may be soon.
- Fed to slow growth? It is expected that when the Federal Reserve suggests the end of easy monetary policy might be approaching, the long-term yields drop temporarily. There is a fear that the Fed will prematurely remove the accommodative policy, threatening the long-term growth outlook.
- Supply has been low: Issuing Treasuries to fund our record debt has been lacking in the months of May and June. May saw the lowest issuance in at least a year, and June’s was down around 3%. Corporate debt issuance was also down 22% (YoY).
- Liquidity with few options: Even with the surge in consumer spending and high equity prices, there is around $4.5 trillion in money markets. German yields are negative out to 2050, UK 10YR yields are around 60 bps (basis points) below the U.S.’s 10 YR. Even the yield on high yield debt is at a record low. There are limited options to put money for safety and yield.
The Bottom Line:
We think yields at these low levels are unsustainable. While growth rates may be peaking, it does not mean growth is contracting—our expectation for solid growth warrants higher yields.
This material was prepared by Verdence Capital Advisors, LLC (“VCA”). VCA believes the information and data in this document were obtained from sources considered reliable and correct and cannot guarantee either their accuracy or completeness. VCA has not independently verified third-party sourced information and data. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. These projections, market outlooks or estimates are subject to change without notice. This material is being provided for informational purposes only and is not intended to provide, and should not be relied upon for, investment, accounting, legal, or tax advice.
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By Megan Horneman