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Rates: The Beginning of the End

With one more rate hike expected by our macro research group, we believe this is the beginning of the end of the upward move in rates.

March 07, 2019


This Rates sector report is excerpted from the First Quarter 2019 Fixed-Income Outlook.

The fourth quarter of 2018 experienced a substantial increase in capital market volatility. The poor performance of risk assets drove a flight to quality. Treasury yields declined 20–45 basis points across the curve, with the belly outperforming as forward-dated FOMC rate hikes were priced out of the market. Nominal yields declined more than real yields, as the broad move lower in commodity prices drove a decrease in breakeven inflation rates.

Treasury Yields Declined as Market Priced Out Fed Rate Hikes

Rate Implied by Jan. 2020 Federal Funds Futures Contract

Treasury yields declined 20–45 basis points across the curve, with the belly outperforming as forward-dated FOMC rate hikes were priced out of the market.

Treasury Yields Declined as Market Priced Out Fed Rate Hikes

Source: Guggenheim Investments, Bloomberg. Data as of 12.31.2018.

Inflation Breakevens Narrowed as Nominal Yields Declined More than Real Yields

Nominal yields declined more than real yields, as the broad move lower in commodity prices drove a decrease in breakeven inflation rates.

Inflation Breakevens Narrowed as Nominal Yields Declined More than Real Yields

Source: Guggenheim Investments, Bloomberg. Data as of 12.31.2018.

The significant move lower in U.S. Treasury yields generated strong returns for the asset class, delivering a total return of 2.6 percent for the quarter and resulting in a total return of 0.9 percent for the year. Meanwhile, the Agency index produced a total return of 1.9 percent for the quarter, and a total return of 1.3 percent in 2018. Longer maturity Agency auction bonds were not immune to the selloff, as they cleared 20–30 basis points wider in spread than comparable Treasury bonds.

Fed Chair Powell stated that the December hike put short-term rates at the lower end of the FOMC’s estimate range for the neutral rate. Recent experience shows a high sensitivity of modest rate changes on economic activity, supporting this statement. Previous work from our Macroeconomic and Investment Research Group found that given the level of nonfinancial corporate debt to gross domestic product, U.S. corporates could only support rates somewhere in the range of 2.50–3.25 percent before the increase in borrowing costs makes it difficult to continue to service heavy debt burdens. Thus, our Macroeconomic and Investment Research Group’s forecast of one more rate hike in the second half of 2019 suggests this could be the beginning of the end of the upward move in rates for the cycle. One more rate hike implies that 30-year Treasury yields, currently 3.00 percent, will peak below 3.25 percent. It also leaves some room for the Treasury yield curve to flatten, but most of the flattening we expected to see in this cycle is behind us. The 2s/10s and the 10s/30s Treasury yield curves have flattened by 113 and 38 basis points, respectively, against 225 basis points of monetary policy tightening since December 2015. Once the hiking cycle is over, we think more attractive buying opportunities will materialize around the belly of the curve.

Note: “Rates” products refer to Treasury securities and Agency debt securities. Treasury and Agency returns are represented by the Bloomberg Barclays Treasuries index and the Bloomberg Barclays U.S. MBS index, respectively.

—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, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management.

©2019, 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 Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management.