Upside Breakout in Treasury Yields
We’ve had an upside breakout in Treasury yields, and we expect it to continue with a growing economy and Fed rate hikes ahead. Rising interest rates is one of our themes for this year.
Below, you can see two-year and 10-year Treasury yields recently making new cycle highs.
Treasury Yields Are Moving Higher
Source: Bloomberg, as of 3/10/17.
In addition to nonfarm payrolls increasing by 235,000 workers in February, average hourly earnings, shown below, were up 2.8% over the past year.
Average Hourly Earnings Are Up
Source: Bloomberg, as of 3/10/17.
Now, together with inflation inching higher, labor market conditions aligned with the Fed raising rates on March 15. We expect two more tightening moves to follow, as a base-case scenario.
With Treasury yields on the rise, we are favoring opportunities in credit.
Floating rate loans and high-yield bonds1 – traditional and short duration – have historically outperformed investment-grade bonds in episodes of rising Treasury yields.
Performance during Previous Rising Rate Periods
1. Source: Morningstar, 12/31/16. Floating rate loans are represented by the S&P/LSTA Leveraged Loan Index. High-yield bonds are represented by the Barclays U.S. Corporate High Yield Index. Investment-grade bonds are represented by the Barclays U.S. Aggregate Bond Index. Short duration high-yield bonds are represented by the BoA/ML U.S. Cash Pay High Yield BB-B Rated 1-5 Year Index. An investment cannot be made directly into an index. Past performance is no guarantee of future results.
Municipal bonds performed well during the 2004-2006 Fed tightening cycle (see table below). And today, most of the municipal bond yield curve looks attractive relative to Treasurys. Past performance is not a guarantee of future results.
Municipal Bonds Performed Well during the Last Fed Tightening Cycle
Sources: Bloomberg, Morningstar, 12/31/16. For illustrative purposes only. The municipal AAA yield curve is a fair market value index, derived from data points on Bloomberg’s option-free Fair Market Curves prior to 11/13/14. Past performance is no guarantee of future results. An investment cannot be made directly into an index.
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1. Source: Morningstar, 12/31/16. Floating rate loans are represented by the S&P/LSTA Leveraged Loan Index. High-yield bonds are represented by the Barclays U.S. Corporate High Yield Index. Investment-grade bonds are represented by the Barclays U.S. Aggregate Bond Index. Short-duration high-yield bonds are represented by the BoA/ML U.S. Cash Pay High Yield BB-B Rated 1-5 Year Index. An investment cannot be made directly into an index. Past performance is no guarantee of future results.
The information contained herein is general in nature and is provided solely for educational and informational purposes. New York Life does not provide legal, accounting or tax advice. You should obtain advice specific to your circumstances from your own legal, accounting and tax advisors.
Barclays U.S. Corporate High Yield Index measures the market of USD-denominated, non-investment grade, fixed-rate, taxable corporate bonds.
Securities are classified as high yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below. The index excludes emerging market debt.
Barclays U.S. Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment-grade or better fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities, with maturities of at least one year.
BoA/ML U.S. Cash Pay High Yield BB-B Rated 1-5 Year Index is a subset of the BoA/ML U.S. Cash Pay High Yield Index including all securities with a remaining term to final maturity less than 5 years and rated BB through B inclusive.
Barclays Municipal High Yield Index is an unmanaged index consisting of non-investment grade, unrated or below Ba1 bonds.
Barclays Municipal Long 22+ Year Index is an unmanaged index that measures the performance of municipal bonds with time to maturity of no less than 22 years.
Barclays Municipal Bond Index covers the USD-denominated long term tax exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds.
Barclays Municipal Intermediate 5-10 Year Index is an unmanaged index that measures the performance of municipal bonds with time to maturity of more than five years and less than ten years.
Barclays U.S. Credit Index measures the performance of investment-grade corporate debt and agency bonds that are dollar denominated and have a remaining maturity of greater than one year.
Barclays U.S. Government Bond Index is composed of the Barclays Treasury Bond Index (all public obligations of the U.S. Treasury, excluding flower bonds and foreign-targeted issues) and the Barclays Agency Index (all publicly issued debt of U.S. Government agencies and quasi federal corporations, and corporate debt guaranteed by the U.S. Government).
Barclays 1-3 Year Municipal Bond Index consists of a broad selection of investment grade general obligation and revenue bonds of maturities ranging from one year to four years.
S&P/LSTA Leveraged Loan Index is a broad index designed to reflect the performance of U.S. dollar facilities in the leveraged loan market.
Treasury Yield is the return on investment, expressed as a percentage, on the U.S. government’s debt obligations (bonds, notes and bills). In other words, the treasury yield is the interest rate the U.S. government pays to borrow money for different lengths of time. The different types of U.S. Treasuries include Treasury notes, Treasury bills and Treasury bonds, which come in different maturities up to 30 years. There are one-month, three-month, six-month, one-year, two-year, three-year, five-year, seven-year, 10-year, 20-year and 30-year securities.
Duration is a measure of the sensitivity of the price — the value of principal — of a fixed-income investment to a change in interest rates. Duration is expressed as a number of years.
Floating rate funds are generally considered to have speculative characteristics that involve default risk of principal and interest, collateral impairment, non-diversification, borrower industry concentration, and limited liquidity. The Fund may invest in foreign securities. U.S. dollar-denominated securities of foreign issuers can be subject to different risks than U.S. investments, including less liquid trading markets, greater price volatility, political and economic instability, less publicly available information, and changes in U.S. or foreign tax or currency laws and monetary policy. High yield securities (junk bonds) have speculative characteristics and present a greater risk of loss than higher quality debt securities. Funds that invest in bonds are subject to interest rate risk and can lose principal value when interest rates rise. Bonds are also subject to credit risk which is the possibility that the bond issuer may fail to pay interest and principal in a timely manner.
Foreign securities are subject to interest rate, currency exchange rate, economic, and political risks. These risks may be greater for emerging markets. Floating rate loans are generally considered to have speculative characteristics that involve default risk of principal and interest, collateral impairment, borrower industry concentration, and limited liquidity. Issuers of convertible securities may not be as financially strong as those issuing securities with higher credit ratings and are more vulnerable to changes in the economy. Funds that invest in bonds are subject to interest-rate risk and can lose principal value when interest rates rise. Bonds are also subject to credit risk, in which the bond issuer may fail to pay interest and principal in a timely manner, or that negative perception of the issuer’s ability to make such payments may cause the price of that bond to decline.
All investments are subject to market risk, including possible loss of principal. There is no assurance that the investment objectives mentioned will be met. Diversification cannot assure a profit or protect against loss in a declining market.
The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results.
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