The Issue at Hand by Madison Investments
In this Market Brief, Chris Aleman and Mike Sanders break down what’s really driving Treasury yields, why it matters for bond allocations, and how to think about yield curve positioning in today’s environment.
The recent jump in the 10-Year Treasury has reshaped the fixed income landscape, driving a steeper yield curve and creating new opportunities for bond investors. While many investors point to higher oil prices, the story is far more nuanced. Inflation expectations, Federal Reserve policy, fiscal concerns, and shifting market sentiment are all influencing long-term interest rates, and understanding these dynamics can better prepare you and your clients for what comes next.
Key Takeaways
- The 10-year Treasury reflects a combination of factors, not any single headline.
- While higher oil prices have contributed to inflation concerns, investors should avoid attributing recent rate moves to energy alone.
- The Fed’s credibility and commitment to controlling inflation can have a meaningful impact on long-term Treasury yields.
- Higher yields do not automatically translate into better investment opportunities; where you invest along the yield curve can matter more than simply chasing yield.
The Discussion
Chris Aleman: I think I had too much coffee today. I think that’s what it is.
Mike Sanders: Yeah, you are jacked, man.
Chris Aleman: And what’s funny, I literally – my coffee cup is I’ve only had literally like a couple of sips of it.
Chris Aleman: Welcome back to The Issue at Hand. I’m Chris Aleman and I’m joined here by Mike Sanders, fresh off his fishing trip in the Great White North in Canada. How are you doing, man? How was it?
Mike Sanders: It was good. It was good. Didn’t get hooked by any of my kids, so that was positive, and it was a lot of fun.
Chris Aleman: Well, that’s always a winner. That was one of my traumatic stories when I was six years old was having a treble hook in my thumb. So, I appreciate that.
Mike Sanders: Yeah, we lucked out.
Chris Aleman: Well, all right, let’s get started. In this episode, what I wanted to discuss with you was the recent jump in Treasury rates, but specifically what’s been driving it. I know everybody’s been talking about it; there are a lot of things out there, and I want to talk about the factors that are going into it. And one thing that I’m personally curious about, that I hope you touch on, is going to be oil. Not only at the pump, what I think most people are concerned about, but also the refining- how diminished global refining capacity has led to the price increases of things we never think about. Fertilizer, petrochemicals, polymers, aviation, logistics, stuff like that – stuff that we don’t normally talk about.
And I’m curious about that one now. I know oil is only part of the story, so one of the things that I’d like you to start with is, let’s take a step back and go to the basics.
How do you go about determining where the ten-year Treasury should be?
Mike Sanders: Good question. I mean, there are a lot of items that go into where a 10-year Treasury should be. It’s growth and inflation at a basic level. So, where expected economic growth is, where inflation is. You can also add in the items you hear about, like term premium; you think about where near-term Fed funds policy rates might be going. You have fiscal issues as well. Foreign demand. So, it’s a little bit of everything, but at certain points in time, maybe one item might be more important than others. And I think, recently we have seen the uptick in oil that’s definitely helped push rates higher as inflation expectations have risen, and it’s definitely moving the market.
Chris Aleman: Well, you brought up something about the Fed, and what they’re looking for. And I know on some of these things we discuss what their mandate is – to keep inflation down. And we’ve heard the press conferences, we’ve heard the tough talk on inflation, but relating to this, what are they doing to address it? And does your formula that you just laid out, does that still fit today?
Mike Sanders: Yeah, they didn’t do anything to address it yesterday, which was the interesting outcome of that meeting. Not that we expected them to hike, but Warsh definitely has shifted a little bit, it seems like, in terms of how hawkish he is about getting inflation down. And so, what’s been happening in the near term, with respect to Fed policy and how that’s impacting the back end, is that hikes were priced in, and it seemed to be that Warsh was a little bit less willing to hike – at least that’s what the perception is right now. And therefore, the inflation side and fighting inflation in the longer run, that thought was reduced, and so the market started to call it a bluff, and that’s why you saw the 30-year Treasury was how it’s been since 2008, over 5.2%. And a lot of it has to do with if you’re a long-term bondholder, you don’t like inflation, and any sort of hesitancy by the Fed is going to cause issues.
Chris Aleman: I have a feeling that any word that’s going to be coming out is going to be highly scrutinized now because we’re not getting as much information. So that makes sense. The other thing that I had touched on briefly in the intro was oil and how it’s impacted the ten-year Treasury, or even the thirty-year Treasury yields. But how interrelated is the price of oil to the recent movement?
Mike Sanders: It definitely matters. It also matters about the refined products that you had mentioned as well. So, it’s one part of the equation, when you think about trying to explain the movements in the tenure and you’re getting this interesting interaction between a new Fed chair, higher energy prices, the inflation target of 2% PCE core has not been achieved for a long time, and so it’s definitely getting focused on a lot in the context of where we have been and where we probably are going to go in the near term in terms of inflation and how serious Warsh is and the FOMC to fight it.
Chris Aleman: Well, I think that’s an important thing that you mentioned, though, that it is one thing. So even if oil goes up or down, it’s still one thing of many things to be considered, and so it’s not going to be tied to it. But in your opinion, what is the potential catalyst that we can get, maybe the Treasury rates down a little bit, specifically the ten-year down?
Mike Sanders: Any sort of reduction in what’s going on in the Middle East will definitely help. Lower oil prices will definitely cause Treasury yields to fall. I think any sort of commentary from Fed officials over the coming weeks to talk about inflation, talk about the commitment to it, what they’re thinking in terms of hikes. I think all of that more hawkish commentary from the Fed will also be a big indicator. So if I was going to try to figure out, sitting in a chair of what items would be most important, I think oil in the Middle East, Fed officials being more hawkish, and maybe less so fiscal policy at the moment- that’s not going to change very quickly, but longer run that’s going to really, really matter.
Chris Aleman: That’s an important point. One of the last things I wanted to touch on was, when we talk about the ten-year, and we talk about the movements, etc, we also want to discuss whether it’s even fairly valued? Do you think that it’s fairly valued where the ten-year is currently? And if not, if so, are there other opportunities that you’re looking at along the curve that you see as more valuable?
Mike Sanders: It’s always tough to say fair value. I think if you look at positioning across the curve, I do think that there’s a lot of uncertainty out the curve, given all the items that we’ve discussed. And I do think the belly of the yield curve, which, generally is that two to six, two to seven year part of the curve. If you think about if you’re a bond investor and you want to earn some income but maybe reduce the possibility of price impacts you might have with longer bonds, that’d be a great spot to invest and wait and see what happens off the curve.
Chris Aleman: That’s fair. If I can recap what I’m hearing, when yields move higher or lower, don’t always assume it’s one thing. Don’t always assume it’s either inflation or just Fed policy or just oil. There’s always more to it. And I think the second thing that is important for everybody to understand here is also, I think I gathered that yield curve positioning matters. And I want you to touch on that a little bit more.
Mike Sanders: The highest yield doesn’t necessarily mean it’s the best investment. There are reasons that yields go higher, if you will, and there are reasons that parts of the yield curve are higher than where they are shorter in duration, if you were shorter maturity. So, positioning really, really matters. If you were owning a lot of 30-year bonds recently, you’ve taken a price hit because of all the items that we’ve discussed. Well, shorter maturity bonds like the five-year have gone down, but not nearly to the extent. So, it really does matter positioning across the curve, and buying the highest yield, I think, gets investors sometimes into trouble in different periods of time.
Chris Aleman: I think it’s one of those things: don’t always just stretch, make sure you know what you own and make sure you position where you’re comfortable with. So, I think that’s an important point to hit, and I think it’s the point where we should close it out here.
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