The rise of US Treasury yields?

The Sterling Report

By Eugene Stanley

Sunday, March 11, 2018

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What a difference a year makes! Longer-term US Treasury yields have been soaring this year so far, although they fell last year in spite of three policy rate increases by the US Central Bank (Fed), and while the pace of increase may have been expected for some observers, for others it's a bit of a mystery. But, what's driving the current movement in US rates and is the ascendency likely to continue? And what can or should investors do?

It's apparent from the foregoing that unlike short term rates, Fed hiking alone is insufficient to cause longer-term interest rates to rise as longer term rates are more responsive to inflationary impulses. So last year, in the absence of a sustained increase in inflation, longer term yields fell.

This year, at least so far, there have been signs of rising inflation, and expectations of higher future inflation have also risen. Thus, rates have moved up accordingly.

Trump's recently enacted economic policies of massive tax cuts and planned increases in fiscal spending are expected to be both growth stimulating and inflationary (given that the economy is operating at or near full capacity), at least in the short run.

January's year-over-year rise in wages of 2.9 per cent is the largest increase since the end of the Great Recession in mid-2009 and a recent financial report stated that the Atlanta Fed is expecting a US GDP gain of 5.4 per cent in the first quarter of 2018. These developments and others, including Trump's latest proposed imposition of tariffs on steel and aluminum imports, are likely to conjure up faster inflation and prompt the Fed to tighten policy faster, ergo, the prospects of higher yields, or so it seems.

The US 10-year treasury yield spiked to a 4-year high of 2.95 per cent (began the year at 2.41 per cent) in early February following January's wage inflation report but subsequently retraced some of the advance. The 10-year yield again retested four-year highs on February 27th when upbeat comments on the health of the US economy by current chairman, Jerome Powell, were viewed as being “hawkish” – faster rate hikes perhaps, before falling just below 2.9 per cent currently.

The current general consensus however is that the 10-year yield should end the year in the low 3 per cent region, which doesn't appear to be a significant increase from current levels.

The sustained elevation in US treasury yields has been unsettling for both bond and equity investors. We witnessed sharp sell-offs in global equities in February despite the recording of significant gains in January. Some bond investors also saw declines in the value of their portfolios.

It is not a certainty that yields will end the year higher, as inflation (though rising) is still currently below the Fed's target of 2 per cent. It is almost certain however that volatility (and occasional sharp moves) in asset prices will continue throughout the year as market speculation and expectations adjust to incoming economic data and developments.

Should bond investors become overly concerned about rising rates? The answer is it depends. Investing in bonds is usually intended to be for the medium to long-term. As such, short-term downward movements in bond prices should not be too much of a concern for “buy and hold to maturity” investors as long as the credit health (perceived or otherwise) of the issuer does not become impaired.

However, there are investors who buy bonds for not only the income it provides through regular coupon payments, but also for the prospects of capital gains. Rising rates however reduce the prospects for capital gains and is more disconcerting for such investors, who may then opt to sell bonds to realise any existing capital gains or minimise losses and then await better conditions for capital gains (e.g. from market over-reaction).

So going to cash (despite its lower return) to await better opportunities is not necessarily a bad idea.

Some investors may also seek to reduce the maturity profile of their portfolio (opting for shorter dated and or variable bonds) to minimise the impact of rising interest rates (price declines are more pronounced on longer term bonds than on shorter term bonds for the same incremental amount of rate increase).

Shorter dated bonds also return principal much earlier than longer dated bonds and therefore permit the re-investing of principal at higher rates in a rising rate environment. Variable rate bonds also allow investors to benefit from rising rates.

However, prevailing interest rates should not be the only consideration for bond investing and investors are therefore encouraged to consult with their financial advisors before making a decision to buy or sell.

Eugene Stanley is the VP, Fixed Income & Foreign Exchange at Sterling Asset Management. Sterling provides financial advice and instruments in US dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at:

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