Multiple Headwinds Pushing Bond Yields Higher

by: , Managing Director, Economist, and Portfolio Manager, New York Life Investment Management; Amit Soni, CFA, Director and Portfolio Manager, New York Life Investment Management

Since last quarter, we have seen a sharp pickup in U.S. Treasury yields. 10-year yields are up more than 80 basis points (bps) from the lows seen in September last year, and are very close to breaking through the 3% level for the first time since 2013.

10-Year U.S. Treasury Yields

Source: Bloomberg, as of 2/22/18. Past performance is no guarantee of future results, which will vary.

Fed hikes and inflation have been key drivers recently. Breakeven inflation has been rising steadily since the middle of last year, and the Fed has indicated that they are more confident of reaching their 2% inflation target after years of lagging behind.

10-Year Breakeven Inflation

Source: Bloomberg, as of 2/22/18. Past performance is no guarantee of future results, which will vary.

In addition, the supply/demand dynamic for bonds is turning less favorable. Tax reform, the recently passed budget deal for 2018-19, and a potential infrastructure plan are all contributing to a widening federal budget deficit. It will require a substantial rise in issuance to fund the gap. The Treasury may need to borrow $1 trillion in 2018, almost doubling last year’s number.

Net U.S. Treasury Issuance

Sources: U.S. Department of the Treasury, Bureau of the Fiscal Service, as of 1/31/18. Past performance is no guarantee of future results, which will vary.

On the demand side, the Fed continues to unwind its holdings at an accelerating rate. The interest from foreign buyers is also declining with increasing currency-hedging costs. And with deregulation, the demand from domestic banks may also weaken going forward.

With multiple headwinds from the Fed, inflation, and a deteriorating supply/demand imbalance, Treasury yields have more room to rise, and we would wait before substantially adding exposure to the bond market. Investors trying to limit the downside may utilize alternatives and low-duration bonds to manage their portfolios’ duration risk.

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.

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Poul Kristensen, CFA

Managing Director, Economist, and Portfolio Manager, New York Life Investment Management

Poul Kristensen, CFA is Managing Director, Economist, and Portfolio Manager with New York Life Investment Management’s Multi Asset Solutions (MAS) team

Full Bio

Amit Soni, CFA

Director and Portfolio Manager, New York Life Investment Management

Amit Soni is a Director and Portfolio Manager in the Multi Asset Solutions (MAS) team at New York Life Investment Management. He focuses on quantitative and macro-economic investment research and portfolio management for the asset allocation

Full Bio

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