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Topical Research – U.S. Treasury Market Trends

- March 15, 2023

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Treasury Market Trends

Treasury yields of all maturities had been declining since the early 1980s, but the emergence of inflation has triggered a potential regime change

Finally getting paid to wait—yields on short-term government bonds have increased in nominal terms and, if inflation rolls over, may even be prospectively attractive in real terms

Finally getting paid to wait—yields on short-term government bonds have increased in nominal terms, and if inflation rolls over, may even be prospectively attractive in real terms

Parts of the Treasury yield curve remain deeply inverted as inflation and rate hikes have started to take their toll on growth

2s10s Treasury spread fell further in February to ~-80bps, while the 3-month/ 10-year spread narrowed to -96bps after falling to deepest inversion in at least 45 years last month

Fed Funds curve has continued to move higher, following January’s Jobs Report and CPI surprise; rates are expected to reach 5.4% in July and have now caught up (and surpassed) the FOMC’s December dot plot projections

The 2-year to Fed Funds spread was trading at -0.46% at the start of Feb, but has since narrowed with yields moving sharply higher as markets start to accept the “higher for longer” narrative

When the 2s10s spread is above 2%, investors should generally hold longer duration; when it is between 1% and 2%, it is not a home run; and below 1% is a coin toss

Cyclical vs. secular rise? Treasury yields had been in a downward trend for almost 40 years, but may have recently broken out

Federal response to COVID-19 lockdowns resulted in massive deficit spending, which required massive monetization

Government debt jumped as a result of the COVID-19 crisis response

Even with near-record debt levels, interest expense remains low but is expected to double over the next 10 years; weighted average maturity of government debt is 6.1 years

The productivity of debt has been on a downward trajectory since the 1950s, which has negatively impacted economic growth

Roughly 21% of the Fed’s Treasury assets mature within the next 12 months, amounting to over $1.1 trillion

Roughly 21% of the Fed’s Treasury assets mature within the next 12 months, amounting to over $1.1 trillion

Complicating fiscal spending decisions in 2023 is the fact that the debt ceiling (or debt limit) was hit in November at $31.4 trillion

Q1 2023 net issuance was expected to be $932Bn; Treasury cash balance has been worked down due to debt ceiling and now sits at $394Bn

Japan, China and the UK are the largest holders of U.S. treasuries, accounting for ~36% of foreign held bonds; all 3 are dealing with substantial domestic economic issues

Foreigners have stepped back from buying Treasuries; foreign holdings peaked in December 2021 and are down roughly $426Bn since

Fed’s planned balance sheet reduction ($47.5Bn/month from Jun-Aug ‘22 and $95Bn from Sep ‘22) has started to take shape, even if massively lagging planned pace

The Fed has not been able to nearly match the pace they planned to roll assets off their balance sheet; SOMA account runoff is currently behind by $207 billion

The issuance calendar is now uncertain given the debt ceiling debate has prevented typical issuance, but there will need to be catch up later in 2023

The issuance calendar is now uncertain given the debt ceiling debate has prevented typical issuance, but there will need to be catch up later in 2023

U.S. Treasury money market funds saw nearly $60Bn of inflows in Q4, marking the first quarter of inflows since Q4 ‘21; 2022 saw >$200Bn outflows

Market increasingly punishing policy mistakes, especially when you’re not the global reserve currency

The U.S. bond market remains relatively higher yield, which could help keep U.S. rates somewhat contained

The end of an era (no more negative yielding bonds)? We hope so…

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DEFINITIONS

Asset class performance was measured using the following benchmarks: U.S. Large Cap Stocks: S&P 500 TR Index; U.S. Small & Micro Cap: Russell 2000 TR Index; Intl Dev Large Cap Stocks: MSCI EAFE GR Index; Emerging & Frontier Market Stocks: MSCI Emerging Markets GR Index; U.S. Intermediate-Term Muni Bonds: Bloomberg Barclays 1-10 (1-12 Yr) Muni Bond TR Index; U.S. Intermediate-Term Bonds: Bloomberg Barclays U.S. Aggregate Bond TR Index; U.S. High Yield Bonds: Bloomberg Barclays U.S. Corporate High Yield TR Index; U.S. Bank Loans: S&P/LSTA U.S. Leveraged Loan Index; Intl Developed Bonds: Bloomberg Barclays Global Aggregate ex-U.S. Index; Emerging & Frontier Market Bonds: JPMorgan EMBI Global Diversified TR Index; U.S. REITs: MSCI U.S. REIT GR Index, Ex U.S. Real Estate Securities: S&P Global Ex-U.S. Property TR Index; Commodity Futures: Bloomberg Commodity TR Index; Midstream Energy: Alerian MLP TR Index; Gold: LBMA Gold Price, U.S. 60/40: 60% S&P 500 TR Index; 40% Bloomberg Barclays U.S. Aggregate Bond TR Index; Global 60/40: 60% MSCI ACWI GR Index; 40% Bloomberg Barclays Global Aggregate Bond TR Index.