Bonds: Cabinet Appointments Spur Treasury Rally, But Tariff Talk Could Put A Floor Under Yields
December 2024
Calm returned to the bond market in the back-half of November as President-elect Trump announced that he would tap hedge fund manager Scott Bessent to be Treasury Secretary, a move cheered by fixed income investors that led to a rally in long-dated U.S. Treasuries and forced yields lower. Market participants view Bessent as a student of history and rational thinker equipped with the ‘right stuff’ to guide the U.S. government through the challenge of making interest payments on some $35T of debt, all while the budget deficit continues to grow with little near-term spending relief on the way. Tough decisions must be made in the coming year(s), and after focusing issuance on the short-end of the Treasury curve via bills in recent years, the U.S. government needs to term-out borrowing by issuing more long-term notes and bonds. To make this pivot without rattling markets and forcing Treasury yields higher, insurance companies, pension plans, and sovereign wealth funds must buy into the idea that the U.S. government is capable of making strides toward getting its fiscal house in order, and Bessent’s nomination has, at least initially, been viewed as doing just that.
While market participants received clarity on who would lead the U.S. Treasury, certainty on the tariff front may remain elusive for a while longer, putting a floor under long-term Treasury yields. Tariffs on Chinese exports are expected to rise but could end up below the 60% rate bandied about when the President-elect was on the campaign trail, and with recent cabinet appointments taking on a less protectionist or nationalistic tone, “blanket” tariffs on all imports appear less likely. Ultimately, cooler heads should prevail, but tariff rhetoric will be used as a negotiating tactic for some time to come and interest rates will likely remain volatile as a result. A more targeted approach to tariffs would ease fears that inflation could spike and in turn lowers the likelihood that the 10-year Treasury yield is on a collision course with the 5% level, or above, over the near-term. However, we see little downside for yields on long-term Treasuries as investors require greater compensation for taking on interest rate risk amid this highly volatile and uncertain backdrop. As a result, we view core investment-grade bonds, specifically Treasuries, as a ‘clip your coupon,’ at best, asset class over the balance of 2025. U.S. corporate high yield, floating rate bonds, asset-backed securities, and developed market sovereigns abroad all hold appeal for diversification purposes and help lower the volatility profile of fixed income portfolios.
Credit Markets May Have A Little Too Much Cheer Heading Into The New Year. Valuations in below investment grade credit capped off their 4th consecutive month of spread tightening in November, a streak last seen in the second half of 2020. The recent run of spread tightening for high yield bonds has started to dampen the relative appeal of corporate credit. The Bloomberg High Yield Index has returned a hefty 8.7% with just one month to go in 2024, topping the index’s 7.6% yield-to-worst at the start of the year as the combination of credit spread compression and rate movement have driven prices ever higher. Price appreciation in high yield land shouldn’t be taken for granted as it has now only occurred in five of the last ten years with the only other repeat occurrence before the last two years happening in 2016 and 2017.
Those historical statistics alone aren’t enough to drive us out of below investment grade securities, as market ‘firsts’ happen often, but when viewed in concert with ultra-tight corporate credit spreads, the data warrant a deeper dive to ensure one is not taking unnecessary risk in what could be a more volatile market going forward. Valuations are just one factor in forecasting market returns in our approach, but with spreads just 30-basis points above the all-time tight level reached in 2007, investors will likely benefit from taking a more guarded approach to below investment-grade corporate bonds in the coming year. Given our current position in the economic and credit cycle, we see few catalysts for a sizable sell-off in high yield corporates but hold the view that investors should be tempering their expectations for this segment after back-to-back years of above average returns.
As of December 12, 2024
