Bonds: Total Market
They had been paused for a couple of months, but in the last week, things started to change. Treasury yields once again broke above the 3% barrier last Wednesday. The number is a psychologically important and has proved a stalwart level for the yield to breakthrough. It did so earlier this year, before quickly falling back into the 2.8% range. Yields seemed to be pushed higher by a sharp rise in Japanese bonds yields following action by the BOJ.
FINSUM: Treasury yields are hard to handle right now. On the one hand, the economy looks fantastic, which should send them higher, but at the same time the Fed looks hawkish and the risk of recession seems to be rising, which would keep things in check.
In what could come as very welcome news for investors across all asset classes, Fed Chief Powell has indicated that the Fed may take a break from hikes for a while. The question is when this pause in hikes will occur, and the Fed is debating this internally. The central is expected to introduce the words “for now” in regards to its plan for near-term hikes, a new phrase that signals conditionality. According to a former Fed economist, “Given that there’s no visible inflation threat -- not in the data and not in the FOMC forecasts -- it makes sense to inject conditionality on future moves”.
FINSUM: We hate analyzing Fed speak, but a pause in hikes seems like a good idea to us. With inflation low, there is no reason for the Fed to forcefully invert the yield curve and cause a recession.
Bond yields had been rising quickly in the US. The rise seemed to come out of nowhere for American investors, but most analysts said the quick jump in ten-year yields was due to a possible policy change by the BOJ to a less accommodative stance. However, the BOJ announced today that it would make only very minor changes and would remain highly loose in its monetary approach. The bank said it would not join other global central bank’s in tightening policy, and would leave rates ultra low for an extended period.
FINSUM: This is good news for bond investors, as Japanese tightening was interpreted as a major threat. This should help keep US yields looking attractive versus global yields, which will in turn keep them lower.
Investors may need to be very worried about stagnant bond yields. After many weeks of pause, bond yields finally look set to move higher. The ten-year Treasury is approaching 3% and as the good market mood and good economic news continues, it seems there could a surge higher in yields. European yields have also been moving sideways for some time. Improving trade relationships, great earnings, and good economic data mean that the bond market may react all at once in the near-term.
FINSUM: This is an interesting argument—bond yields have been quite stagnant despite good news, and they may ultimately react all at once. Seems plausible right now.
Barron’s has put out an interesting article outlining a key correlation in the muni market. We thought it was worth some coverage. A new study out of the University of Illinois has found that muni bond yields tend to lose when local newspapers shut down. Local media often keep local government spending in check and work as a balance on corruption and mismanagement. A multi-year study of the muni market found that yields tended to rise when these papers shut down. The authors summarize “The loss of monitoring that results from newspaper closures is associated with increased government inefficiencies, including higher likelihoods of costly advance refundings and negotiated issues, and higher government wages, employees, and tax revenues”.
FINSUM: This makes perfect sense to us. The problem is that local newspapers have a bleak future at the moment, so the hopes of them serving as a watchdog in the future looks highly unlikely.
There have been a lot of fears about the junk bond market both over the last few years and in recent months. Many worry what a rising rate period would mean for the sector. However, the bigger worry might actually be a recession. Bank of America Merrill Lynch has recently put out a report analyzing the sector, and they highlight a potentially big worry. As many know, over the last decade, companies have gorged on BBB rated bonds (the lowest rung of investment grade), issuing trillions worth. However, the big risk is that in a recession, default rates will surge, profits will fall, and many of those bonds will be downgraded into junk status. When that occurs, many investments funds will be obligated to sell them because of mandates, which could cause a massive exodus and big losses.
FINSUM: The giant BBB market, which has been the superstar of the high yield sector since the Crisis, seems like it might be poised for a serious rough patch come the next recession.