Fixed Income: All Things Must Pass

Head of Fixed Income Strategy
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Certainly, the lion’s share of the post-election focus within the fixed income arena has been on the U.S. Treasury (UST) market, and rightfully so, considering the recent rate developments across the maturity spectrum. Somewhat lost in the headlines have been some of the changes that have occurred within the rest of the G7 sovereign debt universe.  
Post-Brexit, G7 sovereign debt yields were the “horse leading the cart”  in terms of the direction for the Treasury market, but post-U.S. election, it’s been the opposite. In other words, the rise in the UST 10-Year yield has helped push its G7 counterparts to higher readings as well. However, it should be noted that the overarching rising trend has not been a one-for-one relationship. To be sure, the 10-year rate increases abroad have not kept pace with what has been witnessed thus far in the U.S. To provide some perspective, as of this writing, the UST 10-Year yield has risen 45 basis points (bps) since election day; the remaining G7 increases have been as follows: Japan +7 bps, Germany +9 bps, UK +17 bps, France +24 bps, Canada +29 bps, Italy +37 bps.

U.S. 10-Year vs. 10-Year German Bund

UST v German Bund



As a result, spread relationships, or relative value, have definitely shifted. With the German bund market essentially being viewed as “the Treasuries of the eurozone,” this is where we will turn our attention. Since the “taper tantrum” in 2013, the 10-Year UST/bund spread has been on a rather visible upward trend. From the beginning of 2013 through the recent U.S. election, the spread moved from a low of +25 bps to as high as +190 bps. Post-election, this differential has risen by roughly 40 bps to break through the +200 bps threshold and now resides at its widest reading since 1989!
It is interesting to note that going into the final month or so of the campaign season, foreign purchases of Treasuries had revealed a discernible downward pattern. According to the most recent Treasury International Capital (TIC) data, foreign holdings of Treasuries through September had fallen by $125.3 billion. Mainland China represented two-thirds of this total, or $83.8 billion, dropping its UST holdings to their lowest level since 2012. Unfortunately, the TIC data operate with a one-month lag, so we won’t be able to see the official foreign figures during this post-election surge in UST rates until the January 2017 report.
Will this historically wide spread serve as an incentive for foreign buying of Treasuries? One could make the case that G7 sovereign rate differentials have moved in the UST market’s favor. Another supporting factor comes from the technical side of the equation, as the Relative Strength Index (RSI), which measures whether the UST 10-Year is overbought or oversold, last week hit its highest oversold reading since 1990. That being said, the Treasury arena still seems to be in a phase of determining where the bottom lies, a process that seems to be causing global investors trepidation about jumping in too soon.

Unless otherwise noted, data source is Bloomberg, as of 11/18/2016.

Important Risks Related to this Article

Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. In addition, when interest rates fall, income may decline. 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.
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About the Contributor
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 Managing Director and Chief Fixed Income Strategist for Wealth Management. 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.