Short Treasurys and ditch duration, says Pioneer Investments July 24, 2013, 4:29 PM The rising yields that have characterized the bond markets over the past few months are only the start of a “potentially difficult transition” to a rising rate environment, says Michael Temple, director of U.S. credit research at asset-manager Pioneer Investments. So, looking in the rearview mirror at the “Great Bond Bear Market of 1994” — where investors were caught flatfooted as rates rose — Pioneer is shorting 5-year 5_YEAR +3.55% and 10-year 10_YEAR +0.77% Treasurys and reducing exposure to duration. “You need to actively go short the part of the market that is encountering negative returns,” Temple said in an interview. “We’re shorting Treasurys, not owning much in the way of agency mortgages, and reducing exposure to investment grade corporates.” Treasury yields rose sharply in May and June, dragging yields higher across the bond market as investors fled fixed income on suggestions that the Federal Reserve could begin scaling back its bond-purchase programs later this year, which have helped push down yields. Bond yields settled for much of July as the Fed clarified its intentions of keeping short-term interest rates low even after it concludes its purchase program, but are rising again this week as concerns continue to mount. Temple sees a couple of different potential scenarios for the next climb higher. In a July report, he assigns each a probability, a corresponding Treasury yield, and an investment return by the end of 2014: Bear Case: Employment and inflation rise rapidly, and GDP growth hits above 3%, sending the 30-year yield to 6.5% and the 10-year yield to 5%. Probability: 25%. Return on 10-year: -3.2%. Return on 30-year: -8.3%. Base Case: The economy moves moderately higher, with GDP growth at 2% to 3% over the next two years. That sends the 30-year yield to 5% and the 10-year yield to 4%. Probability 50%. Return on 10-year: -3.1%. Return on 30-year: -8.2%. Stagnant Case: The economy grows at 1% to 2% over the next two years, putting the 30-year yield at 4% and the 10-year yield at 3%. Probability: 20%. Return on 10-year: 0.2%. Return on 30-year: -0.3%. Bull Case: The U.S. stumbles into another recession, pushing the 30-year yield to 2% and the 10-year yield to 1.25% by year-end. Probability: 5%. Return on 10-year: 0.8%. Return on 30-year: 2.1%. The most probable “base case” still saddles investors with negative returns, which underscores the need to reduce duration. Duration is a common measure of the sensitivity of a security to rising rates, and longer-maturing securities usually have the most to lose as rates go up. One the other hand, shorter-duration securities like high yield bonds and bank loans look more attractive, he said. – Ben Eisen
Posted on: Thu, 25 Jul 2013 08:02:31 +0000
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