How to Visually Explain the Rise in Treasury Yields
Treasury rates are on the rise, and yield-hungry investors are making moves to satisfy their appetites.
The 20-Year and 30-Year US Treasury Rates are now higher than the S&P 500 dividend yield, but the opposite was true for most of 2020. Yielding slightly more than 2%, both these long-term rates are back to levels seen roughly a year ago, before the coronavirus pandemic accelerated.
However, the same can’t be said for short-term bills. Though the 20 and 30 year bonds have moved higher, 1-Month, 6-Month, and 1-Year rates have been without a heartbeat for months. At the start of 2020, every US treasury yield was 1.50% or greater, albeit with some slight inversion in short term rates, and the 30-Year topped 2.3%. Two months into 2021, however, the 30-Year to 1-Month yield spread has ballooned to 205 basis points from 80 just a year ago.
This divergence in treasury yields reinforces what many were already thinking or feeling: the market is regaining long-term confidence in the US economy, but the short-term outlook is still uncertain or negative. Despite the split, short-term treasury funds have attracted more investor assets lately, according to fund flow data.
Speculation is also growing on whether or not higher long-term treasury yields are here to stay, given the uptick in inflation. Long-term treasury rates tend to follow inflation, while shorter-term bonds are more sensitive to changes to the Federal Funds rate—hence their current near-zero rates.
Effects of Rising Rates – Winners and Losers
With rates rising off of historically low levels, treasuries are once again becoming an attractive source of yield in investor portfolios. Rising interest rates, coupled with short-term uncertainty, have increased investor appetite for fixed income and led some to sell out of equities. Data from our 2020 Fund Flows Report illustrates this point further.
Cyclical growth stocks tend to underperform in higher-rate environments, since they thrive best when interest rates are falling and liquidity is less expensive. Examples of growth sectors are Technology, Industrials, and Consumer Discretionary, which have leveled off amidst the rise in treasury yields after soaring in the decade-long zero-rate era.
But not all stocks fare poorly due to rising bond rates. Value stocks still perform in higher-rate environments given their reduced dependence on interest rates. Many of these stocks are well-established names with low betas that also have high dividend yields, and can be found in the Communication Services, Utilities, and Consumer Staples sectors, to name a few.
Other laggards in high interest rate environments tend to be bond ETFs containing corporate and government debt. As stocks typically move opposite to bonds, fixed income ETFs are subject to the same inverse relationship of price and yield as their underlying investments. When rates rise, bond ETF share values fall, as has been the case for names like the iShares Government/Credit Bond ETF (GBF).
What History Tells Us About Rising Rates
From 2016 through 2018, the Federal Open Market Committee (FOMC) continually raised the Fed Funds Rate after inflation crossed above 2%. In 2018 alone, the FOMC raised rates four times, likely contributing to the vicious market sell-off at year’s end. The Fed backed off from rate hikes after that, and even made cuts later in 2019.
With long term treasury rates and inflation already rising, it’s worth watching the Fed closely to see what Chair Jerome Powell learned from his predecessor and current Treasury Secretary, Janet Yellen.
But just like a cheap Hollywood re-boot, we all saw this movie prior to the late-2010s. Since 2000, periods with relatively high treasury and Fed Funds rates have immediately preceded recessions, in which rates fell and stocks became more attractive.
Where Are Rates Headed Next?
Inflation and the Fed Funds rate will be closely watched to determine where treasury yields are headed, and to gauge next moves in the stock market. The Fed recently began to issue commentary on rising inflation, downplaying its near-term effects.
One indicator, the Copper to Gold ratio, might point toward the next move in long-term bond yields. Because copper is a cyclical metal, while gold is a “safe haven” during downturns, prices tend to move inversely. The Copper to Gold price ratio has been a solid predictor of long-term yields over the last decade, moving in tandem with the 30-Year treasury.
To find the best funds for your clients, use our Fund Screener to search across over 65,000 mutual funds and ETFs. While you’re at it, read our How to Find the Best Bond ETFs for Client Portfolios for all the best practices to discovering the Best Bond ETFs for your clients.
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