Monday 12 September 2016 by Opinion

US Treasury yields higher — Volatility back from holiday

Volatility hasn’t been eliminated but has just been enjoying the sun loungers in the Hamptons or Monaco; summer is over, the sun loungers are empty and volatility is back on the trading desk

beach chair

Over the last two days, the Dow has lost nearly 450 points or over 2.3% and US Treasuries (UST) sold off with 10yr UST yields 14bps higher at 1.68%.

When bond yields rise and in particular the yield curve steepens, longer dated bonds will underperform.  In this regard, over the course of the last two days, 5yr USTs lost 0.5% in value, 10yr USTs lost 1.3% and 30yr USTs lost 3.0%.  This shows the importance of being aware of and managing interest rate risk in portfolios.

So what caused this move?

The main driver appears to have been investors’ fears of what Central Banks, especially the Fed, will do next.  Indeed, as investors look for clues before the Fed’s knife edge meeting next week, there were two comments on Friday that were of interest.

The Boston Fed President, Eric Rosengren said, “If we want to ensure that we remain at full employment, gradual tightening is likely to be appropriate.  A failure to continue on the path of gradual removal of accommodation could shorten, rather than lengthen, the duration of this recovery.”

He also noted that “a reasonable case can be made” for tightening interest rates to avoid overheating the economy.  Rosengren’s comments were taken as broadly hawkish.

On the flip side and striking a more dovish tone was Federal Reserve Governor Daniel Tarullo who remained cautious about the momentum of the economy but suggested that he is not adverse to the idea of an interest rate hike in the near future.  Tarullo said, “there is room for a robust discussion” and described himself as being a member of the “show me” camp at the Fed, which means that he wants to see “more tangible evidence of inflation” before raising rates.

Tarullo is in the data dependent camp and said, “It’s important for all of us, in going into each meeting, to remain open to the possibility that momentum has changed, that expectations have changed, and thus for us to change our own views.”

Where to next?

Bond investors will be looking for more clues as Fed governor Lael Brainard speaks later today in Chicago.  This will be the last scheduled appearance before Fed officials go into their traditional pre-meeting quiet period before the 20-21 September FOMC meeting.  Some commentators believe that Brainard – who is usually on the dovish side of the ledger – may use this speech to signal that a rate hike is coming.  If that occurred, then investors would have to listen and government bond yields across the curve should increase further.

However, consensus is that Brainard will use her speech to reiterate Tarullo’s dovish take and the timing of her speech is consistent with those she made prior to the March and June meetings.  In both those speeches, Brainard took the opportunity to push patience when talking about hiking.


While we still believe in the lower for longer thesis, over the last several months we have been talking to investors about the need for caution with regards to interest rate risk.  Although we do not expect the Fed to hike rates during 2016, we have been presenting the case for investors to increase exposures to both shorter dated and floating rate bonds in order to help mitigate against the prospect of higher rates.

The last few days have provided investors a gentle reminder of not only the return of volatility but also the impact on asset prices.  As such, asset allocation is critical in protecting investors for a broad based sell off, and a diversified credit portfolio will usually outperform equities in a risk off environment.