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Charting the Market: A New Season of Higher Rates


Head of SPDR Americas Research

  • The path ahead for rates over the next few months is likely going to be the same path birds take – migrating north as the weather turns warmer.
  • How do you position for a higher rate regime?

The standard sixty-forty portfolio garnered double-digit returns in 2020 for only the seventh time in the past 20 years. While this also marked the first back-to-back calendar year of double-digit returns since 1999,1  the victory lap didn’t last long. The bond market hasn’t kept up the pace in 2021.

In fact, in February with rates rising, the only broad-based fixed income sectors with positive returns for the month – and for the year – were high yield and senior loans. All other sectors have stumbled out of the box due to duration-induced price declines and the opposite reaction bond prices have when rates rise.

Fueled by accommodative monetary policies and additional fiscal stimulus, higher inflation expectations and upbeat growth prospects will likely keep upward pressure on rates – and, therefore, weigh on core bond portfolios. So how can you position for a higher rate regime?

Bond portfolios have trouble with the curve

The yield curve (difference between the US 10-year and US 2-year yield) steepened last month to its widest level since 2018, surging to 128 from 96 basis points at the start of the month. This is all from movements in the US 10-year, as it rose by 34 basis points. Catalysts for these moves include dovish comments from the Federal Reserve2 and the US Treasury,3 a weak demand at the US Treasury auction,4 the House passing Biden’s stimulus bill,5 the FDA backing a third vaccine that will increase supply and potentially move herd immunity closer,6 potential technical selling from risk-parity funds as stock and bond correlations have risen,7 and stronger economic data, illustrated by the trend we have seen in ISM prices, as shown below.

manufacturing prices paid vs us 5 yr breakeven rates

Rates moving higher on the long end has flipped term premiums positive for the first time in over three years, as shown below. This trend is further evidence of the market pricing in higher future growth and inflation levels – and of investors requiring a higher yield as compensation on longer maturity bonds.

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1 Bloomberg Finance L.P. as of February 28, 2021 based on the returns of a portfolio comprised of 60% of the MSCI ACWI Index and 40% of the Bloomberg Barclays US Aggregate Bond Index, rebalanced annually.
2 “Fed to Keep Buying Bonds Even As Outlook Improves”, Bloomberg February 23, 2021
3 “Reading Between the Lines: A Conversation With Janet Yellen”, New York Times, February 23, 2021
4 “Treasury Yields Just Spiked After a Brutal 7-Year Auction. What Investors Should Know”, Barron’s February 25, 2021
5 “House Passes Biden Aid with $1,400 Checks”, Bloomberg February 27, 2021
6 “J&J’s One-Shot Covid Vaccine Receives FDA Advisers Backing”, February 26, 2021 US Treasury Curve (10- and 2-Year Spreads) and Term Premium
“Risk-Parity Quants Hammered By Stocks and Bonds Moving Together”, February 26, 2021

Originally Posted on March 8, 2021 – Charting the Market: A New Season of Higher Rates


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