Whether you know it or not, your life and business are run based on the yield of the 10-year Treasury bond. Rates on mortgages, credit cards, student loans, corporate bonds, valuation levels on stocks and thousands of trading contracts are pegged to the so-called risk-free rate. So when a psychological level, in this case 1.0%, is breached, the financial industry worldwide pays attention.
For bond market bears, the breaking of a key level triggers predictions that Treasury yields are going to rip higher. Horizon Investments would take the other side of that argument, and reiterate the need for retirement risk management strategies in a lower-for-longer environment.
The catalyst for the jump above 1% was the Democrats winning Senate runoff elections in Georgia. Investors are anticipating a Democrat-led government means trillions more in stimulus spending, which turbocharges the recovery – and maybe sparks inflation – in the short-term, and adds to the already massive pile of government debt in the long-term.
Contain Your Enthusiasm
Market expectations are getting ahead of reality. The Senate is evenly split, with the tie-breaking vote going to the incoming Vice President. More importantly in our view, the Democratic majority in the House of Representatives shrunk in the last election, and many Democratic members from swing districts don’t support a full-on progressive agenda. That said, more spending is coming from D.C., likely in March after the newest stimulus bill expires.
Before getting too excited about the prospects for fixed-income returns due to higher yields, remember that the 10-year yield was 1.92% a year ago, almost double what it is today. On top of that, spreads on investment-grade and high-yield corporate bonds are near all-time tight levels. Traditional fixed income simply cannot provide yields that come close to historical averages.
Some Stocks Love Higher Yields
The 10-year yield will have a bigger impact on trends in the stock market, however. Bank stocks were the best performing sector on Wednesday. And small-caps, thought of as a greater beneficiary than large-caps, outperformed strongly. The prospect of higher corporate taxes weighed heavily on technology stocks, an aggressive user of tax shelters to lower their tax burdens.
Mr. Powell Can’t Stomach Higher Yields
Most importantly, remember the Federal Reserve cannot stomach the worldwide market dislocations that would be caused by a disorderly rise in 10-year yields. Fed chairman Jay Powell is still fighting the corrosive effects of the economic shutdowns, and in our view, he’ll do what’s needed to make sure the recovery is neither too hot nor too cold.
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This commentary is written by Horizon Investments’ asset management team. For additional commentary and media interviews, please reach out to Chief Investment Officer Scott Ladner at 704-919-3602 or firstname.lastname@example.org.
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