Closing out short-duration tactical tilt as curve flattens.

Ahead of the Curve  

We increased duration in portfolios as the long-term Treasury yields fall below 3%. Throughout the year, we pointed out that foreign conditions were weighing on the outlook. Growth expectations are lower now than in the beginning of the year, and many stock markets around the world are negative for the year. Bulls appear to be pulling in their horns amid concerns over trade, Brexit, and higher short-term interest rates. While Treasury bond yields have been rising for most of the year, that trend now appears to have been broken.

Around the World

Although the U.S. economy continues to look good, evidenced by the unemployment rate still near 50-year lows, the rest of the world appears to be slowing and investors do not have much appetite for risk. The retreat from riskier assets, like global stocks, may be contributing to a flattening of global bond yields. The United Kingdom’s bond market has a 0.14% spread between two-year and five-year Gilts, German Bunds offer a negative yield with five-year government bond yields of -0.3% and two-year yields at -0.6% (a 0.3% spread), and Japan’s two-year government bond is at -0.14% versus -0.13% for 5 year paper. There just doesn’t seem to be any especially attractive place to safely park short-term money across the globe’s major economies. By contrast, the United States 2.7% two-year and five-year notes offer a relatively attractive nominal return versus other global Treasury markets — especially when stock markets are perceived to be risky.

We also see that the trend for spreads between short- and long-term U.S. Treasury yields is generally lower (chart, below). Investors appear to be willing to accept a lower return over short-term T-Bills despite the greater uncertainty involved with holding the bonds for a longer time. In the past, an “inverted yield curve,” which occurs when long-term Treasury yields fall below short-term yields, has often preceded recessions. While we are not seeing recessionary economic trends in the United States, the sharp flattening of the curve recently, coupled with fading investor risk appetite seen in our WCA Barometer and signs of slower global growth, are not positive signals.

Source: Bloomberg

The combination of all of these factors suggests to us that some lengthening of duration on a tactical basis is warranted until we see clearer signs that momentum has once again picked up.

For more on our long-run outlook, please read our latest Quarterly Tactical Asset Allocation Report.

Kevin Caron, CFA, Senior Portfolio Manager
Chad Morganlander, Senior Portfolio Manager
Matthew Battipaglia, Portfolio Manager
Suzanne Ashley, Analyst

(973) 549-4168

www.washingtoncrossingadvisors.com
www.stifel.com  

Disclosures

WCA Fundamental Conditions Barometer Description: We regularly assess changes in fundamental conditions to help guide near-term asset allocation decisions. The analysis incorporates approximately 30 forward-looking indicators in categories ranging from Credit and Capital Markets to U.S. Economic Conditions and Foreign Conditions. From each category of data, we create three diffusion-style sub-indices that measure the trends in the underlying data. Sustained improvement that is spread across a wide variety of observations will produce index readings above 50 (potentially favoring stocks), while readings below 50 would indicate potential deterioration (potentially favoring bonds). The WCA Fundamental Conditions Index combines the three underlying categories into a single summary measure. This measure can be thought of as a “barometer” for changes in fundamental conditions.

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