Investment Strategy Brief:
A Bond Yield Renaissance

Below is a transcript of this week’s video.

Hi, this is Jason Pride, Chief of Investment Strategy and Research at Glenmede.

Federal Reserve Chairman Powell’s reiteration on Friday that an additional rate hike later this year is not yet off the table underlined a storyline of higher rates for longer that is being told by the bond market. Recent weakness in the bond market has pushed the 10-year U.S. Treasury yield to its highest level since the average person was walking around with Blackberrys and flip-phones. With rates now a far cry above the all-time COVID lows, fixed income is now priced much more competitively to other asset classes such as equities.

Everyone knows that the Fed has raised rates significantly to combat the threat of inflation. But an additional catalyst for the rise in longer-term yields is the dichotomy of a loose federal government budget and tight monetary policy. The U.S. government continues to run a major budget deficit, increasing the outstanding supply of Treasury bonds. Simultaneously, alongside its short-term rate hikes the Federal Reserve has been stepping away as an incremental buyer of that debt, as it allows expiring securities to roll off its balance sheet. As a result, the change in the supply of Treasuries relative to demand from purchasers has been a key factor pushing yields higher.

Looking at the yield curve, it is interesting to see that, while it remains inverted with short-term rates still at near 5.5%, the yield provided by longer maturity bonds has risen materially, providing investors the opportunity to lock in these higher rates for longer.  In fact, this option is looking increasingly more attractive relative to shorter-term bonds.

For some time, there were two benefits to being short duration positioning: higher yields and less sensitivity to rising interest rates. But now, this positioning has paid off given the recent rise in yields and the previously mentioned impact on longer-term bonds. Further, these longer-term bonds now appear more attractively valued relative to future expected yields on shorter-term cash.  This illustration shows our valuation model for Treasury bonds, with the yield of bonds with different maturities (shown by the green dots) measured against a corresponding fair value yield and ranges (shown by the blue lines and grey bars). This fair value yield is based on the expected path of cash rates. While the current yields across the maturity spectrum are above the fair value yields, the gap above the fair value yields on the right side is much larger, implying more discounted valuations.

Lastly, with ongoing recession risks, long duration bonds may prove useful as they have historically provided an offset to losses in declining equity markets, as shown in each of the most recent periods of equity market downside in this illustration.

So to summarize:

After years of offering investors paltry yields, rising interest rates have made bonds a competitive investment option.
The recent rise in yields has been driven by a combination of loose fiscal budgets and tightening monetary policy
While the Treasury yield curve remains inverted, longer maturity bonds are beginning to appear incrementally more attractive
With ongoing recession risks, long duration bonds may prove useful as they have historically provided an offset to losses in declining equity markets
Investors should use the recent rise in yields as an opportunity to continue to extend portfolio duration back to more neutral levels

Thanks for listening! And please don’t hesitate to reach out with any questions.

This material is intended to review matters of possible interest to Glenmede Trust Company clients and friends and is not intended as personalized investment advice. When provided to a client, advice is based on the client’s unique circumstances and may differ substantially from any general recommendations, suggestions or other considerations included in this material. Any opinions, recommendations, expectations or projections herein are based on information available at the time of publication and may change thereafter. Information obtained from third-party sources is assumed to be reliable but may not be independently verified, and the accuracy thereof is not guaranteed. Outcomes (including performance) may differ materially from any expectations and projections noted herein due to various risks and uncertainties. Any reference to risk management or risk control does not imply that risk can be eliminated. All investments have risk. Clients are encouraged to discuss any matter discussed herein with their Glenmede representative.