2023 has been remarkable in terms of interest rate volatility and continual changes in market sentiment. In January, market participants had concluded that a Fed pivot was close at hand, and Treasury yields and terminal rate pricing moved lower across the curve. Then in February, employment and inflation data came in stronger than expected, and Treasury yields and terminal rate pricing moved sharply higher again. This trend continued into the first part of March, with terminal rate expectations reaching as high as 5.6 percent before the regional banking crisis led to a substantial drop in the expected path for fed funds. April saw a return to more normal markets but yields still well off the highs.
The Fed continued on its path of fighting inflation with another 25 basis point hike in May, thereby increasing front-end rates further and modestly flattening the curve. The decision came with a notable change in tone that the markets interpret to mean an increased chance of a pause from here, which could keep the curve flat for an extended period. However, we believe that the yield curve will bull steepen—i.e. short-term rates fall faster than long-term rates, increasing the spread between the two—as the eventual easing cycle comes into play next year.
Boosted by heightened interest rate volatility and the Treasury market flight to quality created by banking sector turmoil, Treasury yields declined by 30–40 basis points across the curve, and produced market returns of 3.0 percent during the first quarter. Longer maturity Treasurys fared even better, returning 6.5 percent over the same period. Looking forward, we expect Treasury returns will be positive and primarily driven by coupon income as rates remain relatively rangebound for the next few months with the Fed on hold. A pause by the Fed would be positive for sentiment as a pause is typically followed by an eventual easing cycle, which leads to lower yields and steeper curves.
We continue to take advantage of any moves higher in Treasury yields at the short end and intermediate parts of the yield curve, reducing existing underweight positions there and smoothing duration exposure across the yield curve. Additional moves higher in volatility and interest rates may also present opportunities to buy callable Agency bonds at attractive levels, although ongoing uncertainty around the debt ceiling will likely lead to elevated volatility and continued kinks in the yield curve. Significant bill issuance would likely follow any resolution.
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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, including the possible loss of principal. Investments in fixed-income instruments are subject to the possibility that interest rates could rise, causing their values to decline. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility. Investors in asset-backed securities, including mortgage-backed securities and collateralized loan obligations (“CLOs”), generally receive payments that are part interest and part return of principal. These payments may vary based on the rate loans are repaid. Some asset-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 and valuation risk. CLOs bear similar risks to investing in loans directly, such as credit, interest rate, counterparty, prepayment, liquidity, and valuation risks. Loans are often below investment grade, may be unrated, and typically offer a fixed or floating interest rate.
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*Assets under management is as of 3.31.2023 and includes leverage of $14.7bn. 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. Securities offered through Guggenheim Funds Distributors, LLC.
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