Fixed income perspective – Duration, keep it short.

Fixed Income Perspectives

August 10, 2021

We expect rates to head higher, so keep duration short.

What happened

10-year U.S. Treasury yields have bounced higher in recent days, up to 1.34% today. Friday’s strong jobs report extended the sharp sell-off in U.S. Treasuries, pulling yields further up from their five-month low. The ongoing economic reopening efforts, strong labor market gains, exceptional growth and inflation, and further vaccination progress are the sort of positive developments that typically fuel upward yield momentum. Instead U.S. yields have remained persistently low due to:

  • Since May, a confluence of factors has dragged U.S. Treasury yields lower. Many of these downward forces should ease during the second half of 2021, which we believe will allow low yields to move somewhat higher. Accordingly, we reiterate our stance that below-benchmark duration remains prudent within fixed income portfolios. The Federal Reserve’s (Fed) ongoing quantitative easing
  • Rising Delta variant uncertainty
  • Peak growth concerns
  • Ultra-low foreign yields
  • Seasonal factors in U.S. fixed income markets

Our Take

Since May, a confluence of factors has dragged U.S. Treasury yields lower. Many of these downward forces should ease during the second half of 2021, which we believe will allow low yields to move somewhat higher. Accordingly, we reiterate our stance that below-benchmark duration remains prudent within fixed income portfolios.

Quantitative easing – Lest we forget: the Fed is still buying $80 billion in U.S. Treasury debt and $40 billion in agency mortgage-backed securities (MBS) every month. By definition, these purchases are mandatory and insensitive to yield levels. They equate to an enormous source of demand and a major yield suppressant. However, we believe the Fed will taper its asset purchases in late 2021 or early 2022. As the Fed reduces its supportive role in these markets, the diminished aggregate demand should encourage higher yields.

Delta variant – The rise of the COVID-19 Delta variant is an unsettling development, particularly as a new school year approaches and companies try to increase on-site workers. Concerns have grown over the variant’s ability to disrupt the progress made—not just in the U.S., but globally. Yet, empirical evidence suggests vaccinated individuals are well-protected from the worst health outcomes. That is welcome news given America’s higher vaccination rates relative to many foreign peers, particularly for the most vulnerable (those over age 65). Additionally, the economic impact from Delta’s rise appears limited thus far in the U.S. While regional hotspots are likely to continue, the health and economic threats appear manageable compared to 2020 thanks to the vaccines as well as better treatment drugs and therapeutics. As vaccination and natural immunity rates rise, Delta fears should fade and reduce demand for safe haven assets

Bottom line

The current low U.S. Treasury yields are misaligned with economic realities. We see exceptionally strong trends on virtually all economic fronts—growth, inflation, and hiring, to name a few. While U.S. economic data have peaked, we expect sturdy readings to last well beyond the next couple months. Powerful central bank accommodation, Delta variant concerns, ultra-low international yields and seasonal factors have each played a role in suppressing U.S. yields. However, these forces should ease as we progress through the rest of the year and provide some upward yield lift. These expectations inform our preference to maintain a below-benchmark duration profile in fixed income portfolios.

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