Wednesday, July 22, 2020 |
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| MANAGING DIRECTOR: Scott Carrithers PORTFOLIO SALES AND SERVICE: Steve Panknin • George Morris • Jeff Goble • Chris Thompson • Sean Doherty Kevin Doyle • Lonnie Harris • Mark Tranckino • Robert Schuyler • Tom Toburen Josh Kiefer • Nicole Burczyk • Natalie Regan • Aaron Stoffer • David Farris |
| US Treasury Market | |||||||||||
| Date | 1 mo | 3 mo | 6 mo | 1 yr | 2 yr | 3 yr | 5 yr | 7 yr | 10 yr | 20 yr | 30 yr |
| 07/15/20 | 0.12 | 0.16 | 0.15 | 0.15 | 0.16 | 0.18 | 0.28 | 0.47 | 0.64 | 1.11 | 1.33 |
| 07/16/20 | 0.12 | 0.11 | 0.13 | 0.14 | 0.16 | 0.17 | 0.28 | 0.46 | 0.62 | 1.09 | 1.31 |
| 07/17/20 | 0.11 | 0.11 | 0.13 | 0.14 | 0.14 | 0.18 | 0.29 | 0.47 | 0.64 | 1.11 | 1.33 |
| 07/20/20 | 0.11 | 0.13 | 0.14 | 0.14 | 0.16 | 0.18 | 0.29 | 0.47 | 0.62 | 1.10 | 1.32 |
| 07/21/20 | 0.09 | 0.13 | 0.13 | 0.15 | 0.14 | 0.17 | 0.27 | 0.45 | 0.61 | 1.09 | 1.31 |
Source: U.S. Department of the Treasury, as of 07/21/2020
Mixed-Signals …
Source:Bloomberg LP
Source: Bloomberg LP
So what’s your inflation forecast for the next ten years? If you believe inflation will average less than 1.50%, the current Breakeven Rate, nominal USTNs should be favored, which will out-perform TIPs. Conversely, if you expect inflation will average more than 1.50%, TIPs should be favored, at least in theory, as they’ll out-perform nominal Treasuries.
With the extraordinary fiscal and monetary response to the pandemic, committing to what-ever-it-takes, long term inflation expectations are increasing. As such, commercial bankers may want to consider investing in TIPs. But as a practical matter owning TIPs is more trouble than its worth, as there are accounting issues related to the change in principal from these complicated securities.
As an alternative, commercial bankers concerned about higher inflation in the long run may do well to simply opt for shorter duration securities or, if investing in higher yielding longer duration securities, consider the more defensive structures.
More on this tomorrow.
Mixed-Signals …
Contrary to the steady strength in the U.S. equity market, the bond market continues to signal skepticism regarding the economy ahead and longer term growth. The on-going bid for safe-haven assets, like U.S. Treasuries and gold, as well as the on-going decline in real yields, is a worrisome forecast of trouble ahead. Essentially, the bond market is signaling sub-par growth for quite some time.
Nominal Treasury yields, along with yields from Treasury Inflation-Protected Securities (TIPs) have been declining since their recent peak in late 2018. With the nominal yield of 10-year USTNs cresting at 3.24% on 11/08/18, and the real yield of 10-year TIPs peaking at 1.24% on the same day, the 10-year Breakeven Rate – the difference between the two – was exactly 2.00% in late 2018, implying inflation, as measured by CPI, would average 2.00% through 2028.
Fast forward to today and the 10-year Breakeven Rate is approximately 1.50%, representing the difference between the 10-year nominal Treasury yield of 60 bps and the real yield of negative 90 bps from 10-year TIPs.
Nominal Treasury yields, along with yields from Treasury Inflation-Protected Securities (TIPs) have been declining since their recent peak in late 2018. With the nominal yield of 10-year USTNs cresting at 3.24% on 11/08/18, and the real yield of 10-year TIPs peaking at 1.24% on the same day, the 10-year Breakeven Rate – the difference between the two – was exactly 2.00% in late 2018, implying inflation, as measured by CPI, would average 2.00% through 2028.
Fast forward to today and the 10-year Breakeven Rate is approximately 1.50%, representing the difference between the 10-year nominal Treasury yield of 60 bps and the real yield of negative 90 bps from 10-year TIPs.
Source:Bloomberg LP
Source: Bloomberg LP
So what’s your inflation forecast for the next ten years? If you believe inflation will average less than 1.50%, the current Breakeven Rate, nominal USTNs should be favored, which will out-perform TIPs. Conversely, if you expect inflation will average more than 1.50%, TIPs should be favored, at least in theory, as they’ll out-perform nominal Treasuries.
With the extraordinary fiscal and monetary response to the pandemic, committing to what-ever-it-takes, long term inflation expectations are increasing. As such, commercial bankers may want to consider investing in TIPs. But as a practical matter owning TIPs is more trouble than its worth, as there are accounting issues related to the change in principal from these complicated securities.
As an alternative, commercial bankers concerned about higher inflation in the long run may do well to simply opt for shorter duration securities or, if investing in higher yielding longer duration securities, consider the more defensive structures.
More on this tomorrow.
This information is intended for institutional investors only. The material provided in this document/presentation is for informational purposes only and is intended solely for private use. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.
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