Rates: Keeping an Eye on Fed Tapering

Watch for a possible trade up in quality as credit spreads stay tight.

May 19, 2017

This Rates sector report is excerpted from the Second Quarter 2017 Fixed-Income Outlook.

The market began the year anticipating that reduced regulation and fiscal stimulus would lead to stronger economic growth both in the United States and globally. At the same time, the market was pricing in less than a 25 percent probability that the Fed would increase interest rates at its March 15 FOMC meeting. Given this backdrop, risk assets continued to perform well and Treasury yields remained at the higher end of their recent range. As the quarter progressed, economic data remained supportive, and statements made by members of the FOMC made it clear that a March rate hike was very much on the table. The market repriced accordingly, and the Fed met revised expectations by raising the target range for the federal funds rate to 0.75–1.0 percent.

OIS Market Priced in a Fed Hike After Yellen and Dudley Comments

On March 15, the Federal Open Market Committee (FOMC) raised the fed funds target rate by 25 basis points to a range of 0.75–1.0 percent. The hike itself had little impact on markets because several FOMC members, including Chair Janet Yellen and New York Fed President William Dudley, had indicated in the weeks leading up to the meeting that a hike was likely, allowing the rates market to price in the increase.

OIS Market Priced in a Fed Hike After Yellen and Dudley Comments

Source: Bloomberg, Guggenheim. Data as of 3.31.2017.

The yield curve flattened during the first quarter, with the two-year Treasury yield rising from 1.19 percent to 1.26 percent, and the 10-year Treasury yield falling from 2.45 percent to 2.39 percent, after spending the quarter trading in the 2.31–2.63 percent range. The Bloomberg Barclays U.S. Treasury index returned 0.67 percent for the quarter, and the Bloomberg Barclays U.S. Agency index returned 1.29 percent for the quarter. The Bloomberg Barclays Global Treasury index returned 2.09 percent for the quarter.

Looking forward, we continue to believe that the yield curve will flatten and that a barbell position is appropriate. We believe that the Fed will raise rates in June, and expect to hear more discussion from the Fed over the coming months about reducing the size of its balance sheet. This will likely be accomplished through the tapering of reinvestments as opposed to outright selling, and our Macroeconomic and Investment Research team believes an announcement could come in September. The start of this process, in addition to the evolving fiscal stimulus and Treasury debt management policy discussions, could lead to increased Treasury market volatility throughout the year. Given the strong run in risk assets and tight credit spreads, investors may look to move up in quality, and this could benefit highquality debt. We believe this would be a positive technical for Agency spreads, and we will continue to look for attractive investment opportunities in this sector.

Fed Holdings of Treasury and Agency Debt by Maturity

The minutes of the FOMC’s March 2017 meeting revealed that most officials supported a change to the reinvestment program policy later this year. We expect that the Fed will gradually roll off reinvestments, limiting the market impact at the early stages of the balance sheet normalization process. As the chart shows, however, the end of the reinvestment program may have a bigger effect later in 2018 and 2019 when a significant volume of securities are expected to mature.

Fed Holdings of Treasury and Agency Debt by Maturity

Source: Federal Reserve Bank of New York, Guggenheim Investments. Data as of 4.26.2017.

—Connie Fischer, Senior Managing Director; Kris Dorr, Managing Director; Tad Nygren, CFA, Managing Director

Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management. ©2017, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


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Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Partners Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management.