/perspectives/sector-views/rates-higher-yields-flatter-curve

Rates: Higher Yields, Flatter Curve

Increased volatility could lead to wider credit spreads and a migration to higher-quality fixed-income assets.

May 17, 2018


This Rates sector report is excerpted from the Second Quarter 2018 Fixed-Income Outlook.

The first quarter set the stage for an optimistic 2018 for capital markets: gross domestic product growth finished 2017 on a solid footing and 2018 estimates were similar; employment growth remained strong; inflation was under control; equity markets set new highs; and the new Tax Cuts and Jobs Act of 2017 had just been signed into law. This combination of data and events helped to drive a continued bear flattening of the Treasury yield curve, with yields 20–40 basis points higher across the curve. Increased Treasury supply, which was mostly concentrated at the front end, also contributed to the increase in yields at the front of the curve. On March 21, 2018, in an ongoing effort to continue tightening monetary policy under newly appointed Fed Chair Jerome Powell, the Federal Reserve delivered a 25 basis point increase in the federal funds rate. We have witnessed increased volatility in risk assets and, as the Fed continues its tightening cycle, this volatility is unlikely to subside anytime soon. This increased volatility could lead to wider credit spreads and a migration to higher-quality fixed-income assets. Federal Open Market Committee (FOMC) economic projections remained at three hikes for 2018, although the individual data actually showed a migration toward four expected hikes for 2018. The FOMC projections for 2019 and longer term were revised slightly higher as well. We believe the Fed will raise rates three more times in 2018 for a total of four.

Equity Market Volatility Spiked as the Market Priced a Steeper Path of Rate Hikes

We have witnessed increased volatility in risk assets and, as the Fed continues its tightening cycle, this volatility is unlikely to subside anytime soon. This increased volatility could lead to wider credit spreads and a migration to higher-quality fixed-income assets.

Equity Market Volatility Spiked as the Market Priced a Steeper Path of Rate Hikes

Source: Bloomberg, Guggenheim. Data as of 4.24.18. VIX is the ticker for the Chicago Board Options Exchange SPX Volatility index, which reflects a market estimate of future volatility. LHS = left hand side, RHS = right hand side.

The move higher in yields during the quarter produced negative total returns for the Treasury market. The overall U.S. Treasury index returned -1.2 percent for the quarter. The U.S. Treasury 20+ year index, a proxy for long-end Treasury market performance, returned -3.4 percent for the quarter. The Agency index returned -0.7 percent. The global Treasury index was the positive outlier, delivering total returns of 2.9 percent for the quarter.

Looking ahead we expect the FOMC to increase the fed funds rate by another 25 basis points at its June meeting. We believe that the market will eventually move to expecting a total of four rate hikes in 2018, which would cause the Treasury yield curve to flatten further. A move wider in spreads, along with higher interest rates in general, could present more relative value opportunities in Agency debentures.

Average Number of Hikes per Year Projected by FOMC Participants

FOMC economic projections remained at three hikes for 2018, although the individual data actually showed a migration toward four expected hikes for 2018. The FOMC projections for 2019 and longer term were revised slightly higher as well. We believe the Fed will raise rates three more times in 2018 for a total of four.

Average Number of Hikes per Year Projected by FOMC Participants

Source: U.S. Federal Reserve, Guggenheim Investments. Data as of 3.21.2018.

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

 
Important Notices and Disclosures

Note: “Rates” products refer to Treasury securities and Agency debt securities.

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. ©2018, 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.


FEATURED PERSPECTIVES

July 29, 2019

The Fed's Sugar High

Rational immigration policy, not rate cuts, is the way to avoid recession.

July 17, 2019

High-Yield Credit in a Fed Easing Cycle

High-yield corporate bond spreads and bank loan discount margins typically widen when the Fed is lowering interest rates.

June 17, 2019

Managing While Risk Premia Shrink

The Federal Reserve’s policy pivot has supported a rally in most credit sectors, but investors should worry about late cycle excesses.


VIDEO

Second Quarter 2019 Fixed-Income Outlook 

Second Quarter 2019 Fixed-Income Outlook

Portfolio Manager Steve Brown and Brian Smedley, Head of the Macroeconomic and Investment Research Group, explain that while the Federal Reserve's pause in policy has supported a rally in most credit sectors, investors should worry about excesses continuing to build this late in the cycle.

Core Fixed-Income Conundrum 

Solving the Core Conundrum

Anne Walsh, Chief Investment Officer for Fixed Income, shares insights on the fixed-income market and explains the Guggenheim approach to solving the Core Conundrum.







Read a prospectus and summary prospectus (if available) carefully before investing. It contains the investment objective, risks charges, expenses and the other information, which should be considered carefully before investing. To obtain a prospectus and summary prospectus (if available) click here or call 800.820.0888.

Investing involves risk, including the possible loss of principal.

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. Securities offered through Guggenheim Funds Distributors, LLC, an affiliate of Guggenheim, SI, GFIA and GPIM.

© Guggenheim Investments. All rights reserved.

Research our firm with FINRA Broker Check.

• Not FDIC Insured • No Bank Guarantee • May Lose Value

This website is directed to and intended for use by citizens or residents of the United States of America only. The material provided on this website is not intended as a recommendation or as investment advice of any kind, including in connection with rollovers, transfers, and distributions. Such 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. All content has been provided for informational or educational purposes only and 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. Investing involves risk, including the possible loss of principal.