Rates: Look for Long Duration Opportunities as the Fed Tightens

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

This year is proving to be one of the most difficult investing environments fixed-income market participants have ever experienced. Geopolitical uncertainties, illiquid Treasury markets, and the continued rise in global prices have all led to unprecedented volatility.

As inflation has proven to be anything but transitory, central banks across the globe have had to act in a swift and hawkish manner to defend their credibility, even at the risk of forcing their economies into recession. For its part, by June the Fed had cumulatively raised rates by 150 basis points in 25, 50, and 75 basis point increments, while at the same time wrapped up its massive quantitative easing program.

The Fed’s policy actions led to a bear flattening of the yield curve and a significant move higher in Treasury yields. In the first half of 2022, two-year Treasury yields increased by 220 basis points, and 10-year Treasury yields increased by 150 basis points, narrowing the spread between them to just 6 basis points. Treasurys have experienced their worst first-half returns in the past 50 years, with the index down 9.1 percent through June. Compounding an already challenging environment, liquidity thinned with the Fed no longer buying Treasury securities, which caused bid/offer spreads to widen materially across the curve and magnify the impact of price movements.

We believe that front-end Treasurys will continue to underperform as the Fed continues its tightening campaign, and that the yield curve will likely continue to flatten. For this reason, we favor buying on-the-run Treasurys at the long end of the curve. Further, with the significant underperformance of the 20-year sector, it is possible that the Treasury Department will announce additional cuts to 20-year bond issuance in August, creating an attractive relative value opportunity in that part of the curve.

Looking to the remainder of the year, the Fed’s forward guidance has the market expecting an additional 90 basis points of tightening to a terminal fed funds rate of about 3.25 percent. However, the release of rapidly evolving economic data will likely present the FOMC with some policy decision challenges which either slow down or accelerate the pace of tightening.

—By Kris Dorr and Tad Nygren

Important Notices and Disclosures

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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.

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