Macro: Sandcastle economics
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From the first week, the market reveals a challenging year ahead for the bond market
Althea Spinozzi
Head of Fixed Income Strategy
Summary: As Democrats seem likely to secure the majority in the US Senate, Treasuries fall with 10-year yields breaking the pivotal 1% level and pointing even higher. Since the beginning of the year, 30-year Treasury yields rose of approximately 15bps resulting in a loss of around 2% for bondholders in only three trading days, revealing that duration will be toxic in 2021. In the meantime, corporates line up to issue debt to secure cheap funding. Although the market is far from a complete meltdown, leverage is rising to levels we haven't seen for almost 20 years, making the market even more sensitive to rising yields.
We have started the new year with the 10-year Breakeven rate breaking above 2% and reviving the reflation story. Now that Democrats are about to secure the majority in the US Senate, we can only expect more bearish sentiment in Treasuries which will inevitably push yields higher.
Today, the 10-year US Treasury yield has broken above the pivotal 1% level. Suppose a Democratic win in Georgia is confirmed. In that case, yields could continue to rise and break above 1.1% on their way to 1.5% as many have pointed out. Besides these critical levels, I feel it's essential to highlight that the bond market's pain is real and here to stay.
The US yield curve has been steepening steadily since August until today. Since the beginning of the year, the 5s30s widened by around 10bps. The movement has been concentrated in 30-year Treasuries yields inflicting a loss of about 2% for bondholders in only three trading days.
If 30-year yields close the year with at 2.5% rising about 70bps, the loss that bondholders would face is approximately 15%.
Although there are no signs of a market meltdown yet, it's clear that it has arrived the time to reconsider duration, as long-term bonds are most vulnerable to rising yields.
Corporates are also starting to realize that rising yields might pose some obstacles ahead.
In an effort to secure cheap financing, companies are lining up to issue bonds as soon as possible. In only two days, the US investment-grade corporate primary market has seen $40bn in bonds issuance. It is a record if we compare this data with the first two business days of the past five years. This week's corporate bond issuance could easily surpass the one of the past few years reinforcing the notion that rising yields could pose serious refinancing risk for over-leveraged companies.
Although there aren't signs of a market meltdown yet, one cannot ignore that leverage is at the highest level since early 2000, making the market more vulnerable to higher interest rates.
Therefore, it is time to reconsider duration and close those positions that although have provided solid returns in 2020, have become too risky now.
To name a few: iShares 20+ Year Treasury Bond ETF (TLT), Vanguard Long-Term Corporate Bond Index Fund (VCLT), SPDR Portfolio Long Term Treasury ETF (SPTL), Lyxor ETF iBoxx Liquid Corporates Long Dated (COUK).
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