Author: David Olnick, Investment Executive
Monday morning’s release of the CPI data was generally in line with expectations albeit the year over year change came in very slightly higher but still managed to show an 0.01 decline to an annualized rate of 6.4%. That is still a long way from the FED’s stated target of 2.00%.
- Early reaction in equities has been erratic with stocks moving both higher and lower in volatile trading, however, as of this writing equities are breaking down. Bond yields, on the other hand, have been moving higher again and it is the rise in yields that is pushing stocks lower.
- Since November, the 2 year treasury yield has moved within a range of roughly 4.50% to 4.08%. Early February saw the recent low yield in 2 year treasuries as investor confidence was gaining that the FED was almost done with rate hikes. Reaction to the last 0.25% rate increase was positive in that yields fell on the announcement of the rate hike while stocks gained. However, that enthusiasm was quickly reversed 2 days later when the monthly employment report for January showed a much stronger gain in jobs than what had been expected. That put an end to the treasury rally and since then, yields have been rising again.
- At this point, the bond market is repricing itself back to 2 more ¼ point rate hikes which would take the Federal Funds rate to 5.00% – 5.25%. As a result, today we are seeing short-term treasury yields at 5.00% for the first time since 2006/2007 (see chart below). Currently it is the 6 month treasury that has pierced 5.00%, the 1 year T-Bill is not far behind however.
- 10 year treasury yields which had recently moved to near 3.40% are now back to 3.75%. Once again, short-term yields are rising faster than long-term yields resulting in another record inversion of the 2 year treasury yield versus the 10 yield treasury yield at negative 86 basis points thereby demonstrating a rising conviction that a recession is coming down the pipeline. There remains a lot of diverse opinion, however, as to how deep or shallow a recession might be.
- As it currently stands, I am not overly concerned that rates may be headed “meaningfully” higher. I am, however, more convinced that yields will remain elevated for longer since I see the path towards the 2.00% inflation target as taking much longer than many may be expecting. This should be good news for bond investors.
- For these reasons, I believe that bond investors can use any uptick in yields to add to positions. Especially those who are buyers of tax-exempt/municipal bonds, extending duration in order to lock in longer-term yields as yields move higher while, at the same time, maintaining short-term investments thereby employing a barbell type approach.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of the author and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise. There are special risks associated with investing in bonds such as interest rate risk, market risk, call risk, prepayment risk, credit risk, reinvestment risk, and unique tax consequences. Investments in municipal securities may not be appropriate for all investors, particularly those who do not stand to benefit from the tax status of the investment. Municipal bond interest is not subject to federal income tax but may be subject to AMT, state or local taxes. U.S. government bonds and Treasury bills/notes are guaranteed by the U.S. government and, if held to maturity, offer a fixed rate of return and guaranteed principal value. U.S. government bonds are issued and guaranteed as to the timely payment of principal and interest by the federal government. Treasury bills are certificates reflecting short-term (less than one year) obligations of the U.S. government. Treasury notes are certificates reflecting intermediate-term (2 – 10 years) obligations of the U.S. government. To learn more about these risks and the suitability of these bonds for you, please contact our office.
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