Insights

As the summer months got under way, it seemed as though the fixed income markets would enjoy a peaceful respite from the tumultuous first half of 2018. Alas, it was not to be. The bond market found itself buffeted by economic data as well as global/political events.

Against a backdrop of record setting equity markets, sinking emerging market currencies, potential trade wars (and resolutions thereof), strong corporate profits, and solid domestic economic growth, bond markets were fairly sanguine during the month of August. The 10-year U.S. Treasury note closed the month at a yield of 2.84%, about 12 basis points (bps) lower than where it began. The 2-year note fell 5 bps, as the yield curve maintained its flattening trend.

July proved to be an uneventful month for the U.S. Treasury market, with one exception: rates hardly budged until July 20 when the 10-year note yield rose by 11 basis points (bps) over the course of two days. At month-end, the 10-year yield was at 2.96%, up 10 bps from June’s close. The yield curve flattened modestly, with the 2- to 10-year slope ending the month at 31 bps.

Welcome to the Experiment Economy! The first experiment started some 10 years ago, as the Federal Reserve Board engaged in unprecedented quantitative easing in an effort to prevent a financial system meltdown. Universally considered a success by analysts, now it is time to for the Fed to engage in the second half of its experiment: reversing course. 

 

Since its origination in 1986, the London Interbank Offered Rate (LIBOR) has been a standard benchmark for short-term rates. LIBOR is reset daily based on submissions from a collection of contributing banks. These banks submit yields at which they believe they could obtain short-term loans from other banks. The average rate sets the benchmark for floating rate securities and other financial transactions. 

U.S interest rate markets had a topsy-turvy month. At mid-month the 10-year Treasury note yield spiked to 3.10%, before rapidly falling to 2.78% and finishing the month at 2.83%. The shape of the yield curve followed suit, initially steepening before flattening. At month-end, the 2-10 year spread was 43 basis points (bps), nearly unchanged from the prior month. 

Interest rates rose in April, with the 10-year Treasury yield piercing the 3.0% level for the first time since 2014, before closing the month at 2.94%. The slope of the 2- to 10-year portion of the yield curve changed little; the 10- to 30-year curve flattened. Despite the rise in rates, the bond market appeared to shrug off stock market volatility and the trade war rhetoric that dominated the news early in the month.

What a difference a new year makes! Having been lulled into complacency with respect to volatility, financial markets – particularly the domestic equity markets – got a rude awakening in early February. Suddenly, the “short vol” trade came to a screeching halt, and equities entered a period of heightened volatility with a distinctly downward trend. Exacerbated by political developments (principally, fears of a trade war), revaluation of tech stocks, and the challenge of rising interest rates, equities finished the period in a downward swoon.

Interest rate worries and oversized bets on continued market stability led to severe gyrations in the stock market in February. The Treasury market followed suit, with significant intra-day price fluctuations. The yield of the 10-year note finished the month 16 basis points (bps) higher. The yield curve steepened by approximately 8 bps from 2 to 30 years.

Bond markets sold off in dramatic fashion in January. The 10-year Treasury note yield rose 32 basis points (bps). The yield curve steepened modestly through 10 years, but flattened from 10 to 30 years. Equities posted large gains. The financial markets responded to more positive global economic news, strong earnings domestically, and momentum from the recently enacted Tax Cuts and Jobs Act of 2017.