Sooner Rather than Later Happened
Published January 13, 2021
Head of Investment and Fixed Income Strategy
In my blog post last week, I discussed how the Treasury (UST) 10-Year yield could potentially breach the 1% threshold sooner rather than later. Well, it happened!
The December jobs report did come in softer than expected from a headline perspective, but it didn’t change the bond market narrative. It should be noted that the unfortunate events at the Capitol building last week had no effect on the money and bond markets. The DC-related development that DID impact the bond market was the result of the Georgia run-offs. Here are some key takeaways:
Insights
- With the Democrat victories for the Georgia Senate seats, the ‘Reflation Trade’ came into full focus. The bond market’s take is that the amount of potential fiscal stimulus/spending that could be forthcoming, as a result of the Democrats holding the presidency as well as the House and Senate, more than outweighs any potential negative economic consequences from higher taxes and renewed regulatory efforts.
- As far as the jobs report goes, total nonfarm payrolls fell by 140,000 versus a consensus forecast for a 50,000 increase. For what it’s worth, weekly jobless claims held steady and the unemployment rate remained at 6.7%.
- This soft reading should not be all that surprising given the surge in COVID-19 and its attendant negative effects. The job declines were in the usual suspects, namely, leisure & hospitality.
- Interestingly, other December data points, e.g., manufacturing and service-related PMIs, remained solidly in expansion territory.
- The UST market is looking beyond the jobs numbers and focusing on the aforementioned fiscal stimulus/spending aspect. The 10-Yr yield moved above 1.10%, which is the one-year Fibonacci 50% retracement level. The next stop is 1.29%, and if that’s breached, both the one- and five-year analyses then put a move toward 1.50% in play.
- Inflation expectations continue to rise with 10-Year breakeven spreads at 211 basis points, the highest since 2018.
- Other DC news that was somewhat swept under the table: first, the Federal Reserve appears to be in no hurry to change the pace or the composition (maturity breakdowns) of its Treasury purchases, and second, the FOMC minutes and some other Fedspeak last week talked about possible QE tapering later this year. We are keeping an eye on this.
Solutions
- Our ‘Reflation Trade’ theme has taken center stage in bond-land
- Against this backdrop, we would suggest fixed income investors consider:
- The WisdomTree Interest Rate Hedged High Yield Bond Fund (HYZD) vs. bank loans
- The WisdomTree Floating Rate Treasury Funds (USFR) vs. Treasury Inflation-Protected Security (TIPS)
Important Risks Related to this Article
There are risks associated with investing, including possible loss of principal. Securities with floating rates can be less sensitive to interest rate changes than securities with fixed interest rates, but may decline in value. The issuance of floating rate notes by the U.S. Treasury is new and the amount of supply will be limited. Fixed income securities will normally decline in value as interest rates rise.
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. The Fund 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. The Fund may engage in “short sale” transactions where losses may be exaggerated, potentially losing more money than the actual cost of the investment and the third party to the short sale may fail to honor its contract terms, causing a loss to the Fund. While the Fund attempts to limit credit and counterparty exposure, the value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments. Due to the investment strategy of certain Fund’s, they may make higher capital gain distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
About the contributor
Head of Investment and Fixed Income Strategy
Kevin serves as the Head of Investment and Fixed Income Strategy. In this role, he writes macro and fixed income-related content and works closely with the sales, research and marketing teams. In addition, Kevin conducts client-facing webinars and meetings, providing expertise on WisdomTree’s existing and future bond ETFs. 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.