/institutional/perspectives/sector-views/rates-duration-opportunities-as-rates-rise

Rates: Duration Opportunities as Rates Rise

Despite the challenging environment, several compelling investment opportunities are materializing in the government sector.

November 10, 2022


This Rates sector report is excerpted from the Fourth Quarter 2022 Fixed-Income Sector Views.

Persistent job strength and stubbornly high core inflation data have prompted significant revisions to interest rate hike expectations by market participants and given the Fed little reason to deviate from its hawkish policy. Market expectations for another 175 basis points of tightening in this cycle were realized in November with the fourth consecutive 75 basis point hike, bringing the fed funds rate from a range of 3–3.25 percent to 3.75–4 percent. However, the impact on the economy of the 375 basis points in tightening that the Fed has already delivered is beginning to be felt in the economy, with the Fed noting in its statement that, “In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy.” This leads us to believe that there is a good chance that the Fed will downshift the pace of tightening in December.

The decrease in Treasury market liquidity and increase in market volatility has compounded the impact of the sharp increase in the fed funds rate this year. Liquidity has remained challenging amid the continued global tightening cycle, due in part to the lack of Fed purchases of Treasurys and the decrease in participation by foreign investors, exacerbating price swings. All told, the resulting increase in Treasury yields drove the Treasury index down 4.3 percent for the third quarter, and down 13.1 percent year to date. These returns are the worst seen in at least 50 years, and have made for a very difficult year for fixed-income investors.

Despite the challenging environment, several compelling investment opportunities are materializing in the government sector. With long-end Treasury yields hovering around 4 percent and a terminal fed funds rate near 5 percent already priced in, we believe this is an opportune time to consider adding duration at these levels. As recession risk rises with more deterioration in economic data, longer dated bonds stand to benefit as the market pivots from pricing in rate hikes to pricing in rate cuts. Additionally, low coupon, callable Agency bonds with maturities in the 15- to 20-year range offer spread pickup to similar maturity current coupon bullet securities and offer attractive total return potential due to their discounted price.

The Decrease in Liquidity Has Compounded the Impact of Rate Hikes

Bloomberg Treasury Market Liquidity Index

The decrease in Treasury market liquidity and increase in market volatility has compounded the impact of the sharp increase in the fed funds rate this year. Liquidity has remained challenging amid the continued global tightening cycle, due in part to the lack of Fed purchases of Treasurys and the decrease in participation by foreign investors, exacerbating price swings.

The Decrease in Liquidity Has Compounded the Impact of Rate Hikes

Source: Guggenheim Investments, Bloomberg, data as of 10.2.2022. The Liquidity Index is a measure of prevailing liquidity conditions in the US Treasury market. This Index displays the average yield error across the universe of U.S. Treasury notes and bonds with remaining maturity 1-year or greater. When liquidity conditions are favorable, the average yield errors are small. Under stressed liquidity conditions, dislocations from fair value result in large average yield errors. A higher index level indicates more stressed liquidity conditions.

—By Kris Dorr and Tad Nygren

 
Important Notices and Disclosures

This material is distributed or presented for informational or educational purposes only and should not be considered a recommendation of any particular security, strategy or investment product, or as investing advice of any kind. This material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. The content contained herein is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation.

This material contains opinions of the authors, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward-looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.

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: 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.

©2022, Guggenheim Partners, LLC. All Rights Reserved. No part of this document may be reproduced, stored, or transmitted by any means without the express written consent of Guggenheim Partners, LLC.

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VIDEOS AND PODCASTS

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Anne Walsh, Chief Investment Officer for Guggenheim Partners Investment Management, joined Asset TV to discuss macroeconomic conditions, risk, and relative value in the bond market.

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Macro Markets Podcast Episode 26: Mortgage-Backed Securities, Structured Credit, Market Liquidity

Karthik Narayanan, Head of Securitized for Guggenheim Investments, discusses value in the residential mortgage-backed securities market and other ABS sectors. Anne Walsh, Chief Investment Officer for Guggenheim Partners Investment Management, answers a listener question on liquidity. Jerry Cai, an economist in our Macroeconomic and Investment Research Group, brings the latest on the labor picture and an update on China.







© Guggenheim Investments. All rights reserved.

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 Corporate Funding, LLC, Guggenheim Partners Advisors, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management.