Last week we posed the question: With the Fed gradually reining-in stimulus, inflation modest around the globe and sovereign debt (such as Italy’s 3.166% 10-year note) trading at low yield levels, what impetus is there for much higher US long-term rates at the present time? Our answer is: There is no shortage of demand for U.S. Treasuries. As such, there is little impetus for higher long-term U.S. interest rates. Ever since the Fed began purchasing long-term U.S. Treasury securities in June 2011 (as part of “Operation Twist”), market pundits and investors assumed that once the Fed stopped buying, long-term rates would pop. What was apparently disregarded was that by buying Treasuries at any price/yield to push long-term rates lower, the Fed was squeezing some traditional investors out of the market. These investors were forced to seek yield in the next safest fixed income investments (agencies and very-highly-rated corporate debt, etc.). When Fed Chairman Bernanke mentioned tapering last May, Treasury market participants began to back away. However, as the yield of the 10-year note approached 3.00%, these participants and investors who were squeezed out by the Fed came back into the market and pushed the yield of the 10-year note toward the mid 2.00%s. Many investors and advisors were under the impression that, as the Fed began purchasing long-term Treasury debt; traditional Treasury investors remained in the market. Few understood that lower rates (especially when due to Fed activity) can squeeze investors out of the market. What is happening now is; the Fed is tapering, the Treasury is issuing fewer long-term securities and higher rates attracting investors (especially when yields on long-term foreign sovereign debt have declined significantly) have conspired to keep the 10-year note range bound between 2.58% and 2.80% since February 1st 2014. We believe that to get the 10-year note above 3.00%, we will need to see indicated inflation approaching 2.00% and higher long-term sovereign interest rates (I.E. the Italian 10-year will probably have to be much higher than its current 3.18%). Given the growth and inflation conditions in the global economy, we do not see conditions for a 3.00%-plus U.S. 10-year note during (at least) the first half of the year. As this is “Municipal Monday, we would like to comment on the Bloomberg article which compared the potential course of action the government of Puerto Rico might take to the actions taken by the management of Foxwoods Casino. As Foxwoods is located on the Mashantucket Pequot Indian Reservation and is tribal-owned, Foxwoods’ debt is considered sovereign debt of the Mashantucket Pequot Nation and, therefore, cannot be part of a bankruptcy (sovereign tribes cannot file for bankruptcy protection). The solution for Foxwoods’ financial woes was to reach a debt restructuring agreement with is creditors. As a result, Foxwoods’ bondholders received less than par. A similar outcome could face holders of Puerto Rico debt, including G.O.s and (potentially) Cofinas. Although this is not our base case scenario, it is definitely a possibility.
- November 2012 – Present, Wealth Strategies & Management LLC, Stroudsburg PA
- December 2011 – November 2012 – Bond Squad, Kunkletown, PA
- April 1988 – December 2011, Citigroup and predecessor firms, New York, NY
- June 1986 – March 1988 – E.F. Hutton, New York, NY
Or learn more about Bond Squad’s clearly written, expert analysis, click here