Treasury Bonds Ranges Hold

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Creative Commons License photo credit: Neneonline

Following a sharp sell off to start August, the Treasury market bounced back strongly reversing most of the prior week’s losses.

  • Good demand at the latest round of auctions was the key driver of lower yields and helped Treasuries maintain a two month trading range.
  • A Fed committed to keeping interest rates low and benign inflation should continue to support the trading range over the near-term.
  • Next week brings another bout of supply but the announcement has oftenbeen worse than the actual auctions.

A more stable Treasury market has helped the Barclays Aggregate Bond Index return 3.67% year-to-date through August 13 but performance continues to vary greatly by sector. A stable trading range favors an investment strategy emphasizing sector exposure.

The bond market began last week with trepidation. A dismal start to August left the 10-year Treasury note yield at 3.85% and new supply of 3-, 10-, and 30-year Treasuries raised the possibility of the 10-year note yield retesting the 4% barrier. However, good demand for 3-year notes and 30-year bonds powered the Treasury market higher. The 10-year note auction was weak but a victim of poor timing as the auction concluded just before the conclusion of the FOMC meeting. On a positive note, the 10-year note traded higher following the Fed announcement.

Auction Time

Auction results reinforced the notion that demand exists for Treasuries at current interest rate levels. The auctions also continued the trend of relatively good auction demand that began in early June. The 30-year bond auction provided the biggest catalyst. Since the 30-year bond possesses the most interest rate risk, better-than-expected demand was particularly supportive for the market. Auction strength helped the Treasury market maintain the two-month trading range as defined by a 3.3% to 4.0% yield range on the 10-year Treasury note.

The trading range in Treasuries received additional support from the Federal Reserve, which reinforced a commitment to keeping short-term rates low. The official statement released at the conclusion of the FOMC was little changed from the prior meeting. The Fed announced it would wind down its $300 billion in Treasury purchases by October but this was already expected by the marketplace. The coming end of Treasury purchases is another step along the Fed’s path of gradually removing nontraditional forms of monetary stimulus, also known as “quantitative easing”.

We believe much more of the quantitative easing measures will be retracted before the Fed increases the Fed funds rate. Friday’s CPI inflation report also supported Treasuries. Overall inflation was unchanged in July with core CPI up only 0.1%. Bond investors more closely scrutinize core inflation and annualized core CPI slowed to 1.5% in July, with consensus forecasts calling for a decline through year end. Further declines in core CPI will be supportive for bonds.

Interest Rates Still Low

A Fed committed to keeping interest rates low and benign inflation should continue to support the trading range over the near-term. The Fed and inflation have historically been the key drivers of interest rates. With the 10-year Treasury note yield already up 1.3% year-to-date, we would likely need to see Fed rate hikes or acceleration in inflation to push yields beyond the upper end of the current range. We see neither over the short-term.

The Treasury market has a one week breather before another round of auctions but the announcement has often been worse than the auctions themselves. This Thursday, August 20, the Treasury Department announces details, including total dollar amount to be sold, of the following week’s auctions. The announcement, which occurs the week prior to any auction, has often had a greater market impact.

The table shows the yield change over a two-day period that includes announcement/auction date and the subsequent trading day. We focus on the 5- and 10-year notes not only for their benchmark status but also for their different auction cycles: the 5-year note is auctioned in the same week as 2- and 7-year notes, and the 10-year is auctioned in the same week as 3- and 30-year Treasuries.

The Treasury supply announcement could push Treasury yields higher this week but it will take more than the announcement to alter the trading range. The Treasury market has shown remarkable resilience to both stronger equities and improving economic data over the past few weeks. Additional strength in both will likely be needed to break the yield range.

A trading range favors sector exposure.

A more stable trading range has helped the bond market returns 3.67% year-to-date through August 13. Through mid-June, the broad bond market as measured by the Barclays Aggregate Bond Index was roughly unchanged for the year. The more stable environment in Treasuries, which comprises 25% of the broad market, has helped interest income play a more dominant role and boost performance. We continue to believe the bond market is on pace to deliver a total return at the low end of our mid- to high-single digit 2009 return forecast.

The overall performance of the bond market continues to mask the variance among sector performance. Credit sensitive sectors, such as Corporate Bonds, continue to lead performance by a wide margin. Based on our view of the trading range holding, sector exposure, with an emphasis on Corporate Bonds, remains the right strategy for bond investors to optimize performance.

IMPORTANT DISCLOSURES

  • The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you,consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
  • Neither LPL Financial nor any of its affiliates make a market in the investment being discussed nor does LPL Financial or its affiliates or its officers have a financial interest in any securities of the issuer whose investment is being recommended neither LPL Financial nor its affiliates have managed or co-managed a public offering of any securities of the issuer in the past 12 months.
  • Government bonds and Treasury Bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fi xed rate of return and fi xed principal value. However, the value of funds shares is not guaranteed and will fluctuate.
  • The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
  • High Yield/Junk Bonds are not investment grade securities, involve substantial risks and generally should be part of the diversified portfolio of sophisticated investors.
  • GNMA’s are guaranteed by the U.S. government as to the timely principal and interest, however this guarantee does not apply to the yield, nor does it protect against loss of principal if the bonds are sold prior to the payment of all underlying mortgages.
  • Muni Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and state and local taxes may apply.
  • Investing in mutual funds involve risk, including possible loss of principal. Investments in specialized industry sectors have additional risks, which are outlines in the prospectus.
  • Stock investing involves risk including loss of principal.

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