BNP AM

The sustainable investor for a changing world

Hurricanes cyclone from space

The decline in US real (inflation-adjusted) yields over the last five months has frustrated many investors who had counted on a rise; instead, yields have touched new lows.   

US real yields plunged in 2020 with the imposition of lockdowns across the country and additional quantitative easing from the Federal Reserve, falling below the previous historic low from December 2012 hit during the eurozone debt crisis (see Exhibit 1).

With the discovery of effective coronavirus vaccines late last year, many investors anticipated a sell-off in real yields. This initially occurred, albeit modestly, aided by Democratic victories in Senate elections in Georgia, which raised market expectations for large-scale fiscal stimulus and above-average growth.

What is happening with real yields?

The surprise has been the subsequent rally in yields that took the 10-year yield to new lows, frustrating many investors who had been betting on the opposite.

Yields rebounded by 17bp in August as comparatively high vaccination rates appeared to slow the spread of the Delta coronavirus variant, and the Fed signalled it was moving closer to tapering its monthly USD 120 billion in asset purchases. Yields, however, have remained near the bottom end of the range they have been in since the summer of 2020.

Those investors who believed yields would stay low and held onto their Treasury Inflation-Protected Securities (TIPS) did well over the summer. Monthly inflation data came in much higher than expected, which boosted TIPS prices.

In addition, both real and nominal yields fell on the back of the spreading Delta variant, which paused the economy’s reopening. Nonetheless, we believe there are reasons to expect a move higher in real yields.

Real yields should be higher

Our fair-value model suggests that real yields should be 50 to 60bp above current levels. Two of the key drivers for nominal yields falling over the summer (moderating GDP growth expectations and the Delta wave) should fade (see Exhibit 2).

We expect Covid infection rates to peak in the near future as vaccination rates rise and the wave naturally crests (as has been the pattern in Europe). Several months of economic data coming in below expectations means that it is now more likely that upcoming data will beat forecasts.

The recent statement from Fed chair Jay Powell supported the market’s view that the central bank intends to announce the start of tapering at the November Federal Open Market Committee meeting, with purchases slowing from December through to the summer of 2022.

Tapering purchases should lead to higher yields as the Fed buys less, but the Treasury will also likely be reducing its bond issuance, meaning the net effect on yields could be neutral. An increase in the fed funds rate looks unlikely until the second half of next year. Lacking a strong, short-term monetary impulse, we see only a modest increase in real yields ahead.

Reading the labour market signals

A key driver of taper timing is the speed of recovery in the US labour market. After more than one million jobs were created in July, August disappointed with just 235 000. We nonetheless expect job growth to recover. As exceptional unemployment benefits end and the services sector recovers alongside falling Covid infections, we could yet see strong payroll growth in the months ahead.

Tellingly, 10-year Treasury yields rose slightly on the day of the latest payrolls announcement. This suggests the market believes the drag from the Delta variant on leisure and hospitality jobs will be temporary; at the same time, in August, job growth in industries less affected by Covid was close to previous months.

There is also the view that FOMC policymakers are reluctant to delay the QE taper. The recent increase in Treasury yields may imply that market positioning is now more neutral after having been short real yields (i.e., positioned for yields to rise) over the past few months.

Beyond the stand-alone merits of a short US real yield trade, the position can also act as a hedge for a multi-asset portfolio tilted towards risk, particularly equities. Valuations on US stock markets may be vulnerable to an increase in the discount rate applied to future earnings. A short (real) yield position could help to offset any equity price decline.


Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Related insights

Weekly investment update - November miscellaneous
Fixed income outlook – The temporality of inflation
Authors - Blog
Click on pictures for more details
Weekly investment update – A history lesson
BNPPAM

In the U.S., this material is for Institutional use only – not for public distribution. This material is provided for educational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Reliance upon information in this material is at the sole risk and discretion of the reader. The material was prepared without regard to specific objectives, financial situation or needs of any investor.

These documents and video clips may also include information obtained from affiliated investment management companies within BNP Paribas Asset Management, the brand name of the BNP Paribas group’s asset management services. The documents and video clips are produced for informational purposes only and do not constitute: 1. an offer to buy nor a solicitation to sell, nor shall they form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. investment advice. Any opinions included in these documents and video clips constitute the judgment of the author/ presenter at the time specified and may be subject to change without notice.

This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, and estimates of yields or returns. No representation is made that any performance presented will be achieved by any funds, or that every assumption made in achieving, calculating or presenting either the forward-looking information or any historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BNP PARIBAS ASSET MANAGEMENT USA, Inc. to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

FOR INSTITUTIONAL AND FINANCIAL PROFESSIONAL INVESTOR USE ONLY. THIS MATERIAL IS NOT TO BE REPRODUCED OR DISTRIBUTED TO PERSONS OTHER THAN THE RECIPIENT.

BNP PARIBAS ASSET MANAGEMENT USA, Inc. is registered with the U.S. Securities and Exchange Commission as an investment adviser under the Investment Advisers Act of 1940, as amended. BNP PARIBAS ASSET MANAGEMENT USA, Inc. is a registered trademark of BNP Paribas or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners. © 2021 BNP PARIBAS ASSET MANAGEMENT USA, Inc., All rights reserved.