What Goes Up Has Definitely Been Coming Down

kevin-temp2
Head of Fixed Income Strategy
Follow Kevin Flanagan
09/10/2020

While the headlines surrounding the August Employment Situation report seemed to focus on the moderating pace of new hiring activity, in my humble opinion, the bigger story was the sizable drop in the unemployment rate.

The markets and headlines tend to focus more on nonfarm payrolls (new hiring), and I have no quarrel with that, so let’s first get some perspective on that front. Total nonfarm payrolls rose by about 1.4 million workers, right around consensus forecasts. However, the overall gain was elevated by the hiring of 238,000 temporary census employees. Nevertheless, job gains were broadly based, which is an encouraging sign. New hiring has now recouped nearly 50% of the total job losses that occurred during March and April.

Total Nonfarm Payrolls

Figure 1_Nonfarm Payroll

Back to my main focus, the unemployment rate. It shrank 1.8 percentage points in August, falling to 8.4%. The most important part of this update is that the decline came in the wake of a huge gain of 968,000 in the civilian labor force (another encouraging sign). However, civilian employment surged by nearly 3.8 million workers, or nearly four times the increase in the labor force—it’s just simple math.

Unemployment Rate

Figure 2_Unemployment Rate

Bond Market Implications

As of this writing, the U.S. 10-Year Treasury yield had reversed some of last week’s decline, heading back up to the 0.70% mark. For the near term, I envision more of the same—a range-bound pattern. But, as I noted in last week’s blog post on the Federal Reserve (Fed), a move back toward the 1% threshold remains the base case.

With the Fed’s new ‘average inflation targeting’ policy framework, the monthly jobs report will be losing some of its cachet. We all know the Fed won’t be raising rates for quite a while even if we get some blowout jobs reports in the months to come. Remember, there will be no more pre-emptive rate hikes to ward off potential inflation. The Fed will have to wait to see the ‘whites of inflation’s eyes’ before pulling the trigger.

How Should Fixed Income Investors Consider Positioning Their Portfolios?

Fixed income investors should consider duration shortening strategies with the goal of complementing core bond holdings. The WisdomTree Interest Rate Hedged High Yield Bond Fund (HYZD) can be paired with the WisdomTree Yield Enhanced U.S. Aggregate Bond Fund (AGGY) to potentially achieve this outcome.

 

Important Risks Related to this Article

There are risks associated with investing, including the possible loss of principal. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. HYZD seeks to mitigate interest rate risk by taking short positions in U.S. Treasuries (or futures providing exposure to U.S. Treasuries), but there is no guarantee this will be achieved. Derivative investments can be volatile and these investments may be less liquid than other securities, and more sensitive to the effects of varied economic conditions. 

Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. Investing in mortgage- and asset-backed securities involves interest rate, credit, valuation, extension and liquidity risks and the risk that payments on the underlying assets are delayed, prepaid, subordinated or defaulted on. Due to the investment strategy of AGGY, it may make higher capital gain distributions than other ETFs. Please read each Fund’s prospectus for specific details regarding the Fund’s risk profile.

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About the Contributor
kevin-temp2
Head of Fixed Income Strategy
Follow Kevin Flanagan
As part of WisdomTree’s Investment Strategy group, Kevin serves as Head of Fixed Income Strategy. In this role, he contributes to the asset allocation team, writes fixed income-related content and travels with the sales team, conducting client-facing meetings and providing expertise on WisdomTree’s existing and future bond ETFs. In addition, Kevin works closely with the fixed income team. Prior to joining WisdomTree, Kevin spent 30 years at Morgan Stanley, where he was most recently a Managing Director. He was responsible for tactical and strategic recommendations and created asset allocation models for fixed income securities. He was a contributor to the Morgan Stanley Wealth Management Global Investment Committee, primary author of Morgan Stanley Wealth Management’s monthly and weekly fixed income publications, and collaborated with the firm’s Research and Consulting Group Divisions to build ETF and fund manager asset allocation models. Kevin has an MBA from Pace University’s Lubin Graduate School of Business, and a B.S in Finance from Fairfield University.