Federated: Stay short the 10-year treasuries
Recent activity in the Treasury market has been nothing short of mind-boggling. The 10-year yield had a 37 basis-point swing during 18-hours of trading late Tuesday through Wednesday, falling as low as 1.86% at one point Wednesday, its lowest since the initial stages of the 2013 taper tantrum that erupted that May.
The volatility and downward spikes were fed by more signs of a material slowing in Europe and China, which has caused global commodities prices to plunge and disinflation (and even deflation) worries to mount. Adding to the downward trend—one that surprisingly has been underway on the long end for a while now as slowing global growth and simmering event risk have trumped improving U.S. growth and slow Federal Reserve policy normalization—were comments over the weekend from Fed Vice Chairman Stanley Fischer. He acknowledged that concerns about a slowing global economy and strengthening dollar could prompt the Fed to slow plans to reduce monetary accommodation.
So when Wednesday morning’s report on U.S. September retail sales disappointed, which some interpreted as a sign that the U.S. bright spot in the global economy may be fading, it was like a lit match being tossed into a Treasury market primed for a blowout. The subsequent outsized reaction very much had the feeling of a capitulation blowout, as bears holding on to short positions saw the floor falling out from under them and rushed to the exits while the futures market pushed the timing of Fed tightening further out, to late 2015, and the trajectory to a more gradual path.
Stepping back, it feels to us that the market move was exaggerated by the likely impact of large leveraged trades being unwound. The 10-year yield is at 2.17% at this writing, up 21 basis points from Wednesday morning’s low and 3 basis points from where yields ultimately closed yesterday. This move, on top of much better-than-expected news this morning on U.S. jobless claims (a 14-year low) and September industrial production, indicates to us that a yield bottom has likely been set and that a retracement higher in yields is likely.
Federated thinks the U.S. will continue a meaningful expansion, even amid deceleration in much of the rest of the world, and that the timing and trajectory of Fed tightening has been pushed out and revised downward too aggressively. Thus, the fixed-income committee that oversees recommended duration positioning is sticking with its short duration call. That said, we remain on watch for a move lower and a close below 2% in 10-year yields—such an outcome, which we seriously doubt, may require a reassessment on our part.
Richard J. Gallo is senior portfolio manager and head of Municipal Bond Investment Group as well as head of Duration Committee