Treasuries: The 3% Solution

Mid Week Bond Update

Treasuries: The 3% Solution

After flirting with the 3% level for several days, the yield-to-maturity on the 10-year Treasury briefly crossed...


...that threshold – one that was hyped by financial press as a “magic number” not seen since 2014.

Beyond its symbolic value, the recent rise in the 10-year to the 3% range is really the story of the overall yield curve, which has been flattening in both the 2- to 7-year “belly” and the 10- and 30-year ”long end”. One possible cause: the gently rising credit spread of overall U.S. corporate bonds.

The rising 10-year, relatively far from the Fed-driven short end of the curve, could be implicitly raising the issue of whether the credit quality of corporates might be quietly eroding. That’s surprising, given the generally stable overall spread of U.S. High Yield Corporates, along with a particularly strong corporate earnings season.

But keep in mind that HY credit is concentrated in the energy sector, which has been having a good year due to rising energy prices – suggesting that ex energy, HY spreads may be responding to the same credit issues as corporates overall.

This is far from stating that a recession in the U.S. is right around the corner, or that the U.S. bond market is rendering judgment on the duration of the expected Trump-era stimulus. But it does suggest there might be more to the rise of the 10-year than symbolism – it could reflect a part of the market looking beyond today’s economy into one of several possible futures.

 

The 3% Solution: What's Behind the Curve

Source: Bloomberg, April 24, 2018 Past performance is no guarantee of future results. "YTM" is Yield to Maturity; "bps" refers to basis points, defined as 1/100th of a percentage point. The U.S. Corporate credit spread is the value of the Bloomberg Barclays US Aggregate Average Option-Adjusted Spread, which is expressed in percentage points over U.S. Treasuries of matching maturities. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
 

On the Rise: The U.S. Dollar

On a trade-weighted basis, the U.S. dollar rose just under 1.7% over the past five days, rising against most developed and emerging-market currencies. Credit was given to the strong U.S. earnings season, the perceived growing odds of an additional three rate hikes by the Fed for the balance of the year, and the psychological uplift of improving relations between the U.S. and North Korea.

But it should be noted that a rising U.S. dollar, while driving the costs of U.S. imports down, also makes U.S. goods more expensive for purchasers in other countries. But it takes more than one week’s rise to have a lasting effect on either terms of trade or the prospects for growth in the affected countries.

 

Source: Bloomberg, April 24, 2018 Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

On the Slide: Swiss Franc vs. Euro

In the latter part of 2014, one clear sign the euro was under pressure was investor eagerness to trade euros for Swiss francs. The franc’s relative popularity was problematic for the export-driven country, as well as for the Swiss central bank, whose currency base is comparatively small.

 

Source: Bloomberg, April 24, 2018 Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

In order to protect its exporters, the bank attempted to hold the franc’s value below €1.20, but ultimately caved in early January 2015 and let the currency float against the euro.

One sign of relative tranquility in the Eurozone: with little fanfare, the Swiss franc fell back below its former €1.20 threshold; in response, the central bank said it has no current plans to intervene.

 


Top

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, or a guarantee of future results, or investment advice.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

Yields and dividends represent past performance and there is no guarantee they will continue to be paid.

High yield bonds are subject to increased risk of default and greater volatility due to the lower credit quality of the issues.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.