What is driving the recent volatility in longer-term interest rates, and what does it mean for yield curve positioning?
The volatility in longer-duration assets has stemmed from the country’s fiscal picture and continued uncertainty due to tariffs. We’re spending too much money as a country and will need to rely on foreign investors, in large part, to fund these deficits into the future. Investors are responding to uncertainty by demanding a higher term premium, and, paired with the likelihood of higher long-term inflation, interest rates further out on the curve have pushed higher. Meanwhile, the Fed still aims to lower front-end rates. So, at this point, we have a bias towards the three-to-six-year part of the yield curve.
Does the deficit and demand for U.S. assets have any bearing on the Fed’s thinking as it relates to monetary policy?
The Fed doesn’t directly control many of the factors that are driving long-term rates higher. Their focus remains on the front end of the curve to control the dual mandate of stable prices and full employment. The Fed would likely prefer that the nation spend less, but it has limited tools to influence that directly. We don’t believe we are anywhere close to the kind of environment that would prompt the Fed to step in and buy long-term bonds.
Credit spreads widened in April before moving tighter in May. What is your outlook for the credit market?
Credit spreads have recouped nearly all the widening seen at the beginning of April, and we’ve returned to these very tight levels, despite continued tariff uncertainty and the 90-day delay set to be up in July. We believe the opportunities in corporate bonds are somewhat limited and that high-quality is the place to be, as investors are not being compensated for taking credit risk. We are still finding value in Financials relative to Industrial bonds, but we think it pays to be active and opportunistic in today’s market.
With the volatility in the bond market, why not just be in cash?
From our perspective, cash is not a long-term asset class. It ultimately comes down to reinvestment risk (locking in yields) and diversification (serving as a hedge against other parts of your asset allocation). At today’s levels, with a steepening yield curve, you can put together a high-quality intermediate fixed income portfolio that should yield more than cash. In the event rates fall, the duration impact could bring an even greater total return to the portfolio. Regarding volatility in the bond market, we believe this is an ideal environment for active managers to demonstrate their value by moving in and out of positions across the yield curve and credit spectrum based on their view of relative value and attractiveness, allowing for greater excess return potential compared to cash.