Long-term interest rates are on the rise again. But will it last?
Interest rates have bounced back from their one-year lows of earlier this month, when the yield on the benchmark 10-year Treasury note sank to 3.8%. That move came on news that the U.S. economy added just 78,000 jobs in May, which resulted in a brief buying burst on the notion the
might take a rate-hike breather.
Unfortunately for those early shoppers, the rally in Treasury prices quickly reversed itself and gave way to serious selling. Ten-year yields have since spiked to 4.12%, as Fed Chairman Alan Greenspan suggested his agenda hasn't changed.
Nevertheless, this isn't the first time the market has seen a jump in yields give way to the forces of gravity. And
bond fund manager David Glocke predicts it won't be the last.
Glocke, managing director of the $3.3 billion
Vanguard Short-Term Treasury, the $3.8 billion
Vanguard Inter-Term U.S. Treasury and the $1.9 billion
Vanguard Long-Term U.S. Treasury funds, predicts rates will rise -- but not to the lofty levels some market-watchers expect.
checked in with Glocke to see if he thinks this recent rise in rates is indeed the real deal.
Interest rates are on the rise again after dipping earlier this month on the disappointing May jobs number. In your opinion, is this latest move upward the real deal or just another false start?
I do not think we will see a continued rise in interest rates over time. I would assume we will see some resistance around 4.25% on the 10-year Treasury note. At that point, we will probably see more buying. Beyond that, it really is more data-dependent as far as where we end up going.
Why stop at 4.25%?
Basically because that was the range previously in place before we took the drop after the May jobs report.
How do you manage your funds with this outlook in mind?
We tend to keep the durations of our funds relatively close to their respective benchmarks. We are not allowed to take large duration bets within our portfolios, so we have tight bands that represent our overall outlook on the market whether it's neutral, bullish or bearish.
Even if long-term rates take the step up that you anticipate, they are still trading at historically low levels, despite the Fed's best efforts to pressure the short end. That's the so-called conundrum -- how do you solve it?
It seems that the Fed is keeping interest rates accommodative. We originally anticipated that long-term interest rates would have risen as the Fed raised rates on the short end. That obviously has not taken place.
There have been a number of factors that have influenced that. The first one is the increased demand for long-term assets by insurance or pension accounts looking to match the duration of their liabilities with their assets. In addition, the carry trade has been popular, but as the yield curve has flattened, that particular trade has been less profitable. There are probably some people that have turned around and levered up that much more. And that's exacerbated that flattening effect.
Also, you have had a number of foreign investors that have stepped in to buy U.S. assets because the higher yields make them more attractive than their own domestic instruments.
All of those issues together have caused this 'conundrum' effect. Chairman Greenspan tried to deal with it earlier this year by referencing it and, as a result, we saw long-term interest rates rise accordingly. Subsequently, a month later we rallied to the lows we saw this month.
So what can the Fed do?
That's a hard one because the Fed really does not control long-term interest rates. They impact more of the short end of the market. So as Chairman Greenspan has talked more about long-term interest rates being so low, that's caused some people to start unwinding some of those trades. I really think that's what you are seeing more than anything else right now. It's just a realization that things have gone too far.
How does the dollar's recent strength fit into your outlook?
The strength or weakness of the dollar really does not come into play too much for us. Our portfolio is strictly domestic. Those who are playing the dollar vs. other currencies may be involved in the Treasury market, and so it does flow through into our portfolios, which means we do have some impact from it. But since we are strictly a U.S. dollar-oriented fund, we are not taking a view on the dollar vs. foreign currencies.
When the news first started about the troubles with GM and Ford, there was a flight to quality that took place. You saw a stronger demand for U.S. Treasuries in the market as people assumed that the impact of that event might be larger than it probably really was. So that did cause a temporary effect, but it's really just a contributing factor in the overall rally in Treasuries over the time period.
What about oil's influence on the Treasury market?
The rise in the price of oil can certainly impact consumer spending, which in turn can influence what the Fed may choose to do. If consumer spending drops off significantly, then you may get a slowdown in the overall economy.
We went through a period like that just recently and Greenspan and some others in the Fed characterized it as just a soft patch. Other people in the market, however, saw it as more of a real slowdown. So that's how oil is affecting our Treasury market. It's really just a slowdown in the economy that could come from a sharp rise in the price of oil. But as long as we don't get any sharp spikes, I expect the economy to do quite well.
What should investors be thinking about right now?
I think investors should take a long-term view and diversify their holdings accordingly. That means avoiding market-timing. And ultimately it also depends on the risk tolerance of the individual investor.