After a week of whipsawing US Treasury yields, we have ended up with the benchmark 10-year yield at its highest level since March 20. What can we learn from the recent price action, and where do we think yields could go from here?
The gradual backup in yields since the onset of the pandemic has given Treasuries a little more potency to protect bond portfolios, though we don’t see the rise being anywhere near big enough for them to behave like they used to. However, for investors that sought protection last week as lockdowns became effective across Europe and the US election was at peak uncertainty, longer dated US Treasuries did do a job, albeit a small one. That is provided they took profits quickly enough, of course, as by Monday yields were gapping higher once again as an end to the pandemic flickered into view with Pfizer’s new vaccine.
Bunds, Gilts and other rates markets followed a similar pattern to Treasuries but with less price movement, since their yield curves remain more anchored, making them less effective hedges. On the flipside we think they do offer better stability for credit investing, as we mentioned a couple of weeks ago.
So where do we go from here? With 10-year Treasuries close to 1% now, we think in the short term they should be quite well supported. The technical drivers from intervention are still fully in place and some real money investors will see this as a key support level, and may consider adding capital to their ‘safety’ assets after the recent rally in risk.
Over the medium term our base case is a drift modestly higher in UST yields, driven by large financing needs and a small pick-up in inflation towards the end of Q1 2021.
We would welcome this orderly increase in risk-free yields as it would signal an improvement in the global economy, but also because fixed income investors can use more attractive risk-free rates to provide balance and stability to their portfolios for negative events and for protection later in the cycle.
However, this orderly move higher could take several years as central bank intervention in government bond markets is likely to remain a permanent feature during this recovery.