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Rates: Positioned for a Dovish Fed

Anticipated fiscal stimulus could push 10-year rates above current levels and would present a buying opportunity.

March 11, 2021


This Rates sector report is excerpted from the First Quarter 2021 Fixed-Income Outlook.

Following a year that will be remembered for the devasting human and economic effects of the global pandemic and domestic political uncertainties, 2021 began with some clarity and perhaps even a touch of optimism. While elevated COVID-19 infections and virus mutations around the world continue to signal that the pandemic is far from over, the development and emergency approval of several effective vaccines provided the much-needed hope that the pandemic’s end could possibly be in sight. In addition to the positive vaccine developments, market participants were also buoyed by the Fed’s ongoing commitment to support the recovery through accommodative monetary policy. Furthermore, the election of a Democratic government majority in the United States reassured the market that additional large-scale fiscal stimulus was likely to be on the way. As positive news evolved, the prospects for increased global growth propelled equities to near all-time highs, moved longer term Treasury yields higher, and lifted market-implied inflation expectations.

While the fourth quarter experienced a bear steepening of the Treasury curve with yields increasing 20–25 basis points in the long end, policy easing by the Fed during the first half of the year drove an overall bull steepening for the year, driving yields lower by 75–145 basis points across the curve.

Fed Policy Easing Led to a Steeper Treasury Yield Curve

U.S. Treasury 5-Year/30-Year Yield Curve

While the fourth quarter experienced a bear steepening of the Treasury curve with yields increasing 20–25 basis points in the long end, policy easing by the Fed during the first half of the year drove an overall bull steepening, driving yields lower by 75–145 basis points across the curve.

Fed Policy Easing Led to a Steeper Treasury Yield Curve

Source: Guggenheim Investments, Bloomberg. Data as of 1.29.2021.

This led to significant gains for the Treasury market, with the index delivering a total return of 8.0 percent in 2020. The longer end of the Treasury market experienced even stronger returns, with the Treasury 20+ year index generating an 18.1 percent total return for the year.

Looking ahead, we expect a new round of fiscal stimulus of roughly $1.9 trillion to be passed imminently, which will require higher net Treasury issuance than would have otherwise been the case. This stimulus has boosted growth and inflation expectations and could push 10-year rates to as high as 1.75–2.00 percent, which we would see as a buying opportunity. While we do not expect a broad-based or sustained spike in inflation, inflation expectations have risen, resulting in a steeper yield curve.

Market Implied 10-Year Inflation Expectations Have Recovered

10-Year Treasury Inflation-Protected Securities Breakeven Rate

While we do not expect a broad-based or sustained spike in inflation, inflation expectations have risen, resulting in a steeper yield curve. We believe the Fed’s policy of flexible average inflation targeting—in which the Fed will seek to achieve inflation above 2 percent to make up for periods of below-target inflation—will translate into a longer period of short-term rates at zero than the market is currently pricing in.

Market Implied 10-Year Inflation Expectations Have Recovered

Source: Guggenheim Investments, Bloomberg. Data as of 1.15.2021.

We believe the Fed’s policy of flexible average inflation targeting—in which the Fed will seek to achieve inflation above 2 percent to make up for periods of below-target inflation—will translate into a longer period of short-term rates at zero than the market is currently pricing in. As such, we see attractive carry and roll-down opportunities in the front end and belly of the yield curve.

—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.

©2021, 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 Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Fund Management (Europe) Limited, Guggenheim Partners Japan Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management.