All posts in category: Yield curve (8)

Focus on Fixed Income

Friday, November 17th, 2023

High Yield has the best yield to volatility ratio

Our top-down models are now overweight fixed income, so maybe it is time to work out exactly which categories we want to own and why. We have always liked the yield to volatility ratio, chiefly because it is a good lead indicator of the Sharpe ratio, which an asset will deliver. It contains more information than a study of spreads relative to benchmark, and avoids the underlying assumption that these are somehow mean-reverting. High Yield scores very well on this metric and has done for most of the last two years, which is why we have it as the only category in our fixed income model, where we are overweight relative to benchmark.

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All Trussed Up & Nowhere to Go

Friday, October 6th, 2023

US fiscal profligacy is the new ingredient in this bond crisis

This is a companion piece to last week’s note about the US 10-year Treasury – Why Yields Could Go to 6%. We think we are in a new trading range of 4.3-5.3% and that the biggest single reason for the change is the administration’s plan for 6% budget deficits until the end of the decade. We think there is a significant risk that it will be self-defeating, and that it is too close for comfort to the Liz Truss plan in the UK. We also think that the Fed is happy for bond markets to preach the virtues of fiscal restraint to the administration and is unlikely to ease rates in the absence of a financial accident. The latter is, of course, the most likely outcome of such a dramatic rise in yields.

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Why Yields Could Go to 6%

Friday, September 29th, 2023

But not immediately

We think investors should re-acquaint themselves with the relationship between nominal GDP and 10-year Treasury yields. Over the last 60 years there has been a good relationship between yields and the three-year trend in nominal GDP growth. At the end of Q2 2023, yields were far too low in relation to this trend, much lower than they were in the 1970’s before Chairman Volcker tightened monetary policy in the 1980’s. This sent yields to the top of the range in relation to GDP in just four years. We think that Chairman Powell’s higher for longer stance, coupled with ongoing QT of $900 billion a year, will eventually be as influential in boosting Treasury yields above the trend rate of growth, possibly for a period of several years. We use a variety of forecasting techniques, all of which suggest yields in excess of 6.0% sometime in 2026, but maybe earlier.

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The Great Undiscounted Risk

Friday, August 5th, 2022

Our models expect a bear-steepening in the US yield curve

There is a widespread and unspoken assumption that the Fed will curtail QT if the US economy starts to suffer and that there are no circumstances in which it would accelerate it. We think this assumption needs to be tested. Our models suggest a bear-steepening in the US yield curve is more likely than continued inversion or a bull-steepening. If we are right, this can only be bad news for US and global equities, because our models suggest that the equity rally is completely explained by the recent collapse in 10-year yields. Indeed, equities have underperformed bonds on a risk-adjusted basis since the end of June. If the bond market becomes less supportive later this year, we think there is another significant down-leg in store for equities.

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Some Relief at Last

Wednesday, June 13th, 2018

US Treasuries may bounce in Q3

The risk-adjusted returns of all parts of the US Treasury curve are set to improve over the summer. Our models suggest that investors may be revising down their estimates of the size and scope of future rate hikes from the Fed as evidence mounts of a slowdown in Emerging Markets. This would be consistent with a further flattening of the yield curve and less pressure on spreads in Investment Grade. High Yield already offers the best risk-adjusted returns in US credit. The wild card remains EM Sovereigns; contagion is a real risk, and credit quality may not be an adequate defence.

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My Enemy’s Enemy

Thursday, May 17th, 2018

Bond volatility not necessarily bad for equities

10-year Treasury yields have moved decisively above 3% and there is much excitement about what this could mean for equities. We prefer to look a bond volatility as the basis for comparing the two asset classes. Based on its historic relationship with the slope of the US yield curve, bond volatility is still below its predicted value, while equity volatility is in line with it. The hurdle rate which US Equities have to beat in order to be risk-efficient is therefore too high and would fall if bonds experienced a bout of volatility.

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Fear Volatility not Bond Yields

Wednesday, February 7th, 2018

This is what drives asset allocation

The Great Volatility Slide is Over and it is time to compare the relative impact of rising bond yield vs rising volatility on asset allocation. We conclude that consensus earnings estimates for 2018 provide a substantial margin of safety against the threat of rising bond yields and rising volatility. The margin of safety declines in 2019, but the big threat comes from volatility, not bond yields. On current forecasts, we would need to return to an ultra-low volatility regime in order to maintain an overweight in equities into 2020.

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Financial Rotation

Wednesday, July 12th, 2017

No evidence of co-ordinated global tightening

The new big idea is that Financials are responding to the prospect of a co-ordinated tightening of monetary policy which will steepen yield curves round the world. At a sector level, there is some superficial evidence to support this, but when we look are individual stocks, particularly in Europe, we see that there are other and better explanations.

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