Transcript
Amada Agati:
Fall may be my favorite season, but it seems the bond market didn't get the memo. Interest rates are not falling like the leaves all over my yard. Instead, they're rapidly rising, especially lately.
There's a lot to tackle in this month's addition of "Adding Alpha," so, let's dive right in. Since equity markets hit their year-to-date highs in late July, longer-term interest rates have moved rapidly higher with 10-year and 30-year treasury yields jumping about 100 basis points.
We haven't seen these levels since 2007. So, no matter how you slice and dice that, it's been a violent move. And for once, the fed is not the primary instigator in driving yields up. At a recent interview, Fed Chair Powell was asked his personal view of what's driving interest rates higher. And I was pleasantly surprised to see his answer matched our own.
It's not a simple answer, but some of our primary macro drivers are: The surprising strength in recent economic data. The resiliency of the US consumer. Concerns around the federal deficit and other policy noise in Washington, as well as an increasingly volatile geopolitical environment.
The confluence of all of those macro forces is creating a perfect storm of volatility to come roaring back. In fact, while the VIX hit a post pandemic low in mid-September, it's quickly jumped right back above its 10-year average. Meanwhile, the move index, the bond markets equivalent of the VIX, is hovering around its two-year average. But the last two years of volatility have not been average at all.
The #high volatility regime is back. As a result, the yield curve is actually steepening again. What's unique about the yield curve movement now is that long-term interest rates are rising for all the reasons I mentioned earlier. And this dynamic is known as a bear steepener.
It's so rare to see both a bear steepener and an inverted yield curve at the same time. This only happened once in 50 years. Right before the 1969 and 1970 recession began.
With only one datapoint to go on, it's clearly not much of a guide for what comes next, but we do know it's going to keep the pressure on high valuation stocks and long duration bonds too.
Longer for longer is the name of the game. Whether the Fed has to take another step to tighten policy from here, or market-based interest rates have done the Fed's job for them in the short run, the net effect is tighter policy and tighter financial conditions and elevated volatility.
But it's not all bad news across fixed income markets. Short-term funding markets, really, the plumbing of the financial system have been remarkably calm since the -- since the Fed's started raising rates and even have shown they can absorb more than $1 trillion as the Fed reduces its balance sheet with quantitative tightening.
But that's the treasuring market. What's going on in credit? Credit continues to be in lock step with the stock market. With credit spreads for both IG and high-yield sitting at about their 10-year averages.
While credit spreads tend to be canary in the coalmine signals, where something is amiss in the backdrop, for the most part, credit spreads are well-behaved which is good news.
We haven't seen a material default cycle start yet either. It tells us there's still some time left on the economic cycle clock.
From a bond portfolio perspective, we're still leaning into actively managed, higher-quality, investment-grade fixed income, we're below investment grade and we're just shy of neutral duration.
At some point, we will look to extend duration and lock in yields. But as any investor's seen in the past year thinking rates surely can't get any higher, and then they do just that.
I think there's still significant risk if you try and time a shift in duration because one, the yield curve is still inverted. Two, we're not imminently heading into recession, is when long-term yields would typically start to come down. Three, the Feds' rate hiking cycle may not have officially ended.
