Good Friday AM and start of the summer weekend from your Hometown Lender,
Not much in the way of economic data today.
We have new home sales and that’s about it. Markets are closing early ahead of the holiday. That doesn’t mean we aren’t seeing elevated volatility. This time, guess why? Tariffs again. President Trump has said 1) Apple must pay a 25% tariff on all iPhones made out of the US (if you don’t have a new model, buy it soon) and 2) Goods from the EU will have a 50% tariff starting June 1. If you are in the market for a new handbag for Father’s Day 😊 … Buy it soon. Surprisingly while the tariff news is hitting stocks, it’s actually supporting bonds… whodathunk!!
The WSJ had a good piece on the bond market.
It gives some insight on why we’ve sold off and what might happen next:
Investors hate bonds right now. Treasury yields have surged on the back of President Trump’s tax-and-spending bill, which is expected to further widen the U.S.’s whopping budget deficit. That coincided with a weak 20-year government-bond auction, weighed down by Moody’s downgrade of the U.S. credit rating.
“Bond vigilantes” are also putting pressure on government debt elsewhere—Germany, which is ramping up defense spending; Britain, where borrowing figures are higher than expected; and Japan, long the poster child for high-debt normalcy.
Concern about public indebtedness periodically rises and then falls, and deficits have so far proven sustainable. Even so, the broader question facing many investors is: Why buy a 10-year Treasury yielding 4.5%, and especially a 30-year one yielding 5%, when cash pays 4.3%? That spread made sense when many interest-rate cuts were expected. With the Federal Reserve turning hawkish and the risk of tariff-induced inflation looming, less so.
David Zahn, Franklin Templeton’s head of fixed income for Europe, the Middle East, and Africa, sees the same sentiment abroad. “There is just a lot of uncertainty,” he said. “Most people are saying: I’m not getting paid enough.”
Ultra-long maturity paper in particular tends to be held by the likes of pension funds and life insurers, which have matching long-term liabilities. But if rates stay high—or, in Japan, keep rising—there is far less incentive to buy these bonds.
Inflation-protected bonds have led the rise in yields. It could point to the market anticipating monetary policy being permanently more restrictive, perhaps because of a more geopolitically fraught world with shorter supply chains.
Still, it is good to keep in mind that, relative to history, long-end yields aren’t that high, especially compared to short-end ones. This may ease fiscal worries, but suggests that yield curves have room to steepen further.
So investors have to carefully think about their specific needs when designing a portfolio. If you are building a nest egg you might need to draw upon over the next few years, there may be few places to hide outside of cash, because stock valuations are looking pretty frothy.
However, if you are instead saving for the long term and are able to hold fixed income to maturity, locking in the current Treasury returns could still be worth it. Even if monetary policy retains a hawkish bias, interest rates are still at historically elevated levels and are unlikely to be higher on average over the next decade.
Indeed, the whole point of heightened uncertainty pushing up the “term premium” on longer-term bonds is that buy-and-hold investors get to reap it. Among 30-year Treasurys, it is inflation-protected paper, now offering 2.7% yields, that seems most interesting.
Of course, none of this makes sense if you think Western governments, which are aware that slashing deficits would hurt corporate profits and employment, are on the way to default. If so, forget bonds, stocks and cash, and just buy gold.
Those in this camp are probably wrong, though, because countries that print their own currency ultimately have their central banks to bail them out.
Joining the bond vigilantes isn’t for everyone.
Stay safe, enjoy the holiday weekend, and first, make today great.