UBS sees peak in yields

UBS Global Wealth Management Chief Investment Officer, Solita Marcelli, believes we are close to the peak in yields after the 10-year US Treasury yield rose above 5% for the first time in 16 years on Monday before retreating.

Yesterday's move lower in yields was attributed to news that noted investors Bill Ackman of Pershing Square Capital Management and PIMCO co-founder Bill Gross shifted their bearish bets on bonds. Ackman said his firm covered their bond short as "[t]here is too much risk in the world to remain short bonds at current long-term rates." He added that the economy is slowing faster than recent data suggests. Meanwhile, Gross sees a recession by year-end and anticipates that the spread between two- and 10-year yields, along with the disparity between two- and five-year yields, will turn positive by the end of the year.

Marcelli highlights that yields rose to 5% on the 10-year yield amid three drivers: “higher-for-longer” policy rate expectations amid, a higher natural rate of amid resilient consumption growth and fiscal expansion, and the term premium, or the extra compensation investors require to hold longer-term debt instruments rather than a series of shorter-dated ones over the same period.

From here, the strategist views that we are now close to the peak in yields.

First, the strategist highlights, that as policy rates peak, expectations for the terminal Fed rate stabilize, which is likely to push down growth and inflation over the next six to 12 months, allowing yields to decline. Second, the structural factors that have weighed on the natural rate, such as demographics, debt levels, and productivity, remain unchanged. Third, the term premium may rise due to a deteriorating US fiscal position and political uncertainty, but a significant rapid increase could disrupt Treasury market functioning and necessitate Fed intervention, making it unlikely to reach pre-GFC levels.

Commenting on how investors should invest, the strategist said they prefer high-quality bonds in the five-year point.

“We retain a preference for high-quality bonds in the 1–10-year maturity segment, particularly the five-year point, since running yield and capital upside should quickly reverse recent drawdowns over our tactical investment horizon," Marcelli commented. "Despite a move higher in yields of nearly 100bps, the total return on a five-year high-quality bond investment is essentially flat, demonstrating how higher outright yield levels can protect against mark-to-market volatility. Given the risk that term premiums might increase further, we have implemented a steepening trade on the US yield curve, buying five-year US Treasury bonds and selling 10-year ones."

By StreetInsider.com Staff

You May Also Be Interested In