What’s Behind the Drop in Bond Yields?
Air Date: July 26, 2021
Hi this is Leah Traub, Partner and Portfolio Manager in taxable fixed income.
What is going on with rates? Why is the 10 year yield falling over the last couple of months and is now sitting at below 1.2% here in the middle of July? Well, I’m going to give you three reasons in order of importance.
Title: 1. The Fed
The first is the Fed the Fed was saying, for really, all the past year, that they are going to be reactionary not proactive. What that means is they wanted to see the economy run hot, they wanted to see growth higher they wanted to see inflation meaningfully above 2% so that they could get the average of inflation over their cycle of around 2%. So that’s what they were telling the market and the market responded by steepening the yield curve. June FOMC, the Federal Open Market Committee meeting happened and the tune changed slightly they said we're seeing the high inflation prints that you're seeing. And we're getting a little concerned. And the Fed basically said to the market, we will react. If we get worried about inflation, we will react.
So what the market did is, they said, okay, the Fed may start tapering their bond purchases earlier or more quickly, so they increase rates in the shorter end, but what that meant is that the Fed would be successful at tamping down future inflation, so therefore they decrease rates and the longer end of the market in the 10 year and the 30 year, we’ve seen flattening of the yield curve, since that middle of June.
Title: 2. Covid
Number two: Covid. We can’t escape it unfortunately the rise and the variance has created some concern. We’re seeing case counts go up in the US, but also, and really importantly internationally, where the vaccine rates haven't been as high. You know we're seeing a delayed kind of relaxing of the restrictions and we're even seeing new restrictions being put back on in terms of travel. So people are getting a little bit concerned that this is going to spill over into economic growth.
Title: 3. Fiscal Stimulus
And then, lastly: fiscal stimulus. Earlier this year, there was very high expectations, so we would get a second stimulus package; you know infrastructure related plus other stuff that was going to be really large. The Democrats wanted a really large second package in a couple of trillion dollar range. That seems unlikely at this point. It seems that you know, maybe we will get an infrastructure deal, but it would be a lot smaller maybe we only around 1 trillion, and it will be spread out of course over several years.
So this combination of very accommodative monetary policy and very accommodating fiscal policy that we were really talking about, for the first three four months of the year, that probability has now gone down that we're going to see both of those and we're going to see some removal of accommodation likely in the fourth quarter. We've also probably seen peak GDP growth q2 is probably the peak, so it might be a little rocky for the next six weeks or so, but then, but I think we're going to be back on track.
Thanks for watching and thanks for your continued interest in Lord Abbett.
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