After the 19 basis point rise in the 10 year treasury yield last week this week is starting off with a 3 basis point increase. Trading seems firm in the 1.13% area.
The continuation of rates will start to ‘bite’ a bit each step of the way for holders of low coupon preferreds and baby bonds, although it is a story of ‘how high, how fast‘.
Last week the 19 basis point increase was right on the edge of an increase that could set off some panic selling in income issues. On a historical basis an increase in the 12.5 basis point area in a day gets the attention of investor with a 25 basis point increase sending investors to head for the exits at a hurried pace.
As I noted on the ‘Monday Morning Kickoff this morning the investment grade issues took a bit of a beating last week being off around 2%–they were also the issues that were most overvalued.
For conservative income investors most concerned with ‘immediate income’ instead of total return these drops help to make safe income more affordable, although you capital will drop if rates continue higher. Bottom line is if you liked a low coupon security 2% higher you should be loving it now.
If you have watched the business news much today you have seen a lot of talk on inflation—and inflation expectations are driving rates. Certainly energy prices, which have moved sharply higher in the last month would indicate some inflation is coming into the system, but I think expectations on new ‘stimulus’ is the main culprit. With the new administration coming into power there is some expectation of giant stimulus–maybe a $3 Trillion dollar package–but we shall wait and see.
Though the popular thinking is that the US has $27 Trillion or so of debt and of course the suggestion here is that an additional $3-$5 Trillion of waste and pork added to that will propel rates higher regardless of what the fed does.
But Real or not Real……what I read is that the $27 Trillion number is completely false and when one adds in “contingent liabilities” which normal accounting practices would require, that the actual US deficit is closer to $250 Trillion and even that does not include what are referred to as off the book items like paying off the Savings & Loan Scandal from the 1980s, which I think we’re still paying and who knows what else.
So is the real pressure point $27 Trillion + or $250 Trillion+
Tim – Possibly time to look at TIPS for future inflation protection?
Recent TIPS auctions have all been at NEGATIVE interest rates. The last 5 year TIPS auction was on December 31 with a return component of -1.575%. This gets added to the inflation component, so unless inflation averages more than 1.575% over the next 5 years, you will not earn anything. If inflation averages less than that, you will lose money on an absolute basis. No problem if you decide you want to place a bet on higher inflation, but you should understand what return to expect.
Link to TIPS auction results:
https://www.treasurydirect.gov/instit/annceresult/annceresult.htm
thanks Tex but I was thinking more the ETF version (TIP) which was up about 8% in 2020 and I believe could continue to out perform if inflation expectations continue to pick up in 2021
Tim.. 5-7% preferred .this better then the banks.. 0.30–0.40% still buying ..
A.. rated preferred below or at $25….
The Fed has made it relatively clear that it would not be concerned about near term inflation as long as its outlook for the economy in the second half of the year is optimistic. It would consider rising long term rates to be the result of an improving economy. If such rates rise to rapidly, the Fed will just buy more intermediate term securities. From that perspective, it would seem that it’s okay to nibble at preferred stocks/baby bonds if they have a bad week or two. Not for a short term trade, but for yield improvement for the intermediate term. JM2C
randy–I think the Fed is fine with rates moving some higher–the question is whether they would do too much QE with an improving economy–at some point they need to get out of the way (although I don’t think they will).
“of giant stimulus–maybe a $3 billion dollar package”
If they would limit “stimulus” to only $3 billion that would be a blessing. We have enough debt
You are correct about the higher quality lower coupon issues
I got my eye on USB-Q drifting lower
I do believe there is inflation but my understanding is that the CPI excluded food and energy – so the FED punts on the issue
There is a fundamental flaw with was is going on with inflation now. It is rising on the decline of the dollar – not rising with the quality of living, ie wages
The situation is unfortunate
Pickle–changed that to trillion–but you are correct that $3 billion would be fine with me.
$3 billion is a rounding error for the government.