One of the safe bets during bouts of volatility since the Financial Crisis has been to pile into Treasury bonds anytime things got tough. Every time stocks dipped, the bonds tended to rally strongly and became a safe haven. However, since the recent downturn in equities, this correlation has ceased. Even amidst stock and oil’s plunges recently, Treasuries have basically remained flat, giving no comfort to investors.
FINSUM: The big difference this time around is that the volatility is coming during a period of rising rates, which means Treasury bonds are not as safe a bet as in the past several years.
2019 is shaping up to be a rough year for markets. Growth is weakening, inflation may rise, and the tax cuts’ contributions to earnings and GDP are going to fade. With that in mind, the Wall Street Journal is arguing that gold is likely to be the “best house in a bad neighborhood” next year. One research analyst summarizes gold’s outlook like this, saying “Being long gold has been a tough investment since 2012, and so often, when we see the yellow metal gaining traction, the [U.S. dollar] regains its mojo, and we see the inevitable reversal … However, as we look into our crystal ball and gaze into 2019, emerging warning signs can be seen that suggest 2019 could be the year where gold bulls finally get their day in the sun”.
FINSUM: If asset classes all become correlated and are trending downward, there is a view to gold doing well. However, we are worried about inflation and rates rising, both of which would strengthen the Dollar, and in turn hurt gold.
Everyone is watching the BBB bond market with a very close eye. The bottom fringe of the investment grade market, it saw an extraordinary jump in issuance over the last few years. Now, with rates rising, it looks very vulnerable. However, all that suspicion hasn’t amounted to much as investors have kept the area afloat. Ratings agencies and the IMF have both warned about the startling growth of BBB issuance, but so far, the sector is holding up.
FINSUM: Don’t be fooled. There is a massive amount of BBB debt and when a recession finally arrives alongside much higher rates, there seems bound to be a reckoning. That said, there are pockets of the market, like utilities credits, that seem like they will hold up better.
There are a lot of investors out there worried about rates moving higher and bond prices falling as a result. Treasury yields have moved much higher over the last year, which has spooked investors. All that said, one fund manager thinks investors shouldn’t fret too much. The reason why is that markets likely have already priced in rate hikes in, so losses shouldn’t be much. Furthermore, we have actually entered a more normal yield environment, where one can earn meaningful yields on shorter-term credits that don’t have much interest rate risk.
FINSUM: This article raises a good point about the current yield environment. While rate driven losses are worrying, we have finally entered an environment where one can earn comfortable yields on interest rate hedged portfolios.
Here is something no one was calling for before the election—the yield curve has has flattened considerably since the midterm results. The spread between two- and ten-year Treasuries got as low as 25 basis points. The market thinks the US deficit may be tighter than in an all-Republican scenario, which has sparked a rally in ten-years.
FINSUM: A flattening yield curve on its own does not necessarily indicate recession, but if it does invert, look out, as that is one of the most reliable indicators of a looming slowdown.
Almost all of the market articles regarding the results of the midterms have been about stocks, including which sectors might thrive etc. But the real winner might be the bond market. Treasury yields have fallen and spreads between short and longer term bonds have tightened. The reason why is that traders see the forthcoming US budget as more conservative now that Congress is split. In particular, the market thinks there won’t be a big surge in infrastructure spending, and Treasury bond issuance will probably be tighter, both of which have conspired to boost prices.
FINSUM: It is quite odd to think that the election of a Democrat majority to the House would make the market expect more conservative fiscal policy, but the reality is that a divided Congress will probably be less fiscally loose because of gridlock.