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Treasury yields highest since March ahead of Biden Inauguration

Yahoo Finance’s Brian Cheung and George Bory, Head of Fixed Income Strategy & Portfolio Specialists at Wells Fargo Asset Management, discuss the latest market moves as Treasury yields rise.

Video Transcript

BRIAN CHEUNG: All right, let's take a move on and actually digest what's going on in markets. The big story in markets since the beginning of 2021, which already feels so long ago, has been bond yields, bond yields, bond yields. And the basics of bond yields is that they go up when bond prices go down, which means that people are risk-on.

So what does that mean? We've got George Bory, he's the Head of Fixed Income Strategy and Portfolio Specialist at Wells Fargo Asset Management. And I just want to kick things off, George, with, again, we're looking at the 10-year yield. It's well above 100 basis points at this point. What do you glean as the message from markets based off of the movements that we've seen over the last two weeks or so in that space?

GEORGE BORY: Well, thanks for having me on the show. And as you point out, bond yields are on the move to start 2021. We hit an all-time low in August of last year as the 10-year went all the way down up 50 basis points. And since that point, we've been steadily repricing as, effectively, the trajectory of COVID seems to have started to price in some degree of a recovery, looking sort of six, eight, 12 months out.

And so the bond market, in our opinion, is now starting to catch up to where sort of equity markets already stand, where inflation has started to pick up, and, very importantly, where those growth expectation numbers have started to mount. So as you point out, bond yields are up. They've moved quite a bit. But they're still kind of relatively low by historical standards. So 1.15% on a US 10-year is still very, very low by historical standards, and is still well below sort of the under-- sort of the assumed or expected growth rates that we expect to see later this year.

BRIAN CHEUNG: Now, George, what's really interesting about the run-up in bond yields is that on one hand, it could be optimism over the vaccine and the ability to get over that hump. But it also could be more directly related to the financial concept of the expectation of inflation. When you take a look at things like TIPS instruments, for example, being able to look at the break-even from where people might expect real yields to be in the future, do you think it's more the inflation story that's been driving up bond yields, or really more just optimism over the overall macro outlook?

GEORGE BORY: At this point, it seems like it's more optimism over the economic outlook. As you point out, break-evens have come up. So if we look at the bond market, look at the TIPS market, it is telling you that sort of 10 years out-- five years, five years forward-- that you're likely to see inflation up closer to that 2% target that the Fed is clearly pointing towards and ultimately wants to get to. But we're still a far cry from there.

Core inflation in the last print was around 1.6%. And the underlying trends suggest that inflation should start to pick up. But very few people are expecting a real spike in inflation. The expectation is it's going to gradually climb as we move forward this year. As you point out, hopes about the vaccination kind of rollout for COVID is certainly driving most markets, bond markets included, but also we have fiscal stimulus coming through.

We had an approval of a $600 billion package at the end of last year, with the sort of new administration preparing to come in. Hopes are running high that we're going to see considerably more fiscal stimulus. You take those two factors, you combine it with a relatively easy Fed, and bond yields should be moving higher. It's the logical consequence of a recovering economy.

And so our expectations are that yields are going to continue to creep higher. They never move in a straight line, but we've seen kind of the first leg, if you will, of what's likely to be kind of a multi-leg move higher in bond yields really over the course of this year.

BRIAN CHEUNG: Yeah, George, you mentioned the Fed. It seems like the story has been that it's the dog, which is the Fed, that wags the tail, which might be bond yields. But we've heard the Fed say that it could potentially pursue something like yield curve control kind of tilting its purchases towards the longer end of the curve. But do you think that the movements that we've seen in the 10-year or the 30-year would push the Fed to do that, let's say, this year?

GEORGE BORY: So they might. So I think the short answer is they might, and if they need to, they would. I think you're getting some slightly contradicting signals coming out of the Fed right now. Some Fed members are saying the logical consequence of a recovering economy is higher yields. That would suggest that they are comfortable with where bond yields are now and the gradual move higher in yields. The Fed will tend to sort of have-- you know, they will both respond to nominal levels as well as kind of the velocity on how quickly we get there.

We don't think we're at the point where the Fed really needs to think about a kind of a twist operation. The 2-year versus 10-year yield curve spread is just over 100 basis points right now. That's not particularly high by historical standards. That should not be constraining on growth. And then on the flip side of that, what the Fed has talked about with a fair degree of emphasis is the need for fiscal policymakers to kind of help the economy recover, to help individuals, to help corporations as we work our way through the impacts of the COVID pandemic.

And that's precisely what policymakers are doing. So I think they would want to support the market. If yields were to move materially higher very, very quickly-- if we're talking about 2% yields in a month's time, then the Fed may need to intercede. But at and. 1.25%-- maybe between 1.25%, 1.50% bond yields in a growth environment that's likely to run close to 5% this year is not inconsistent at all.

BRIAN CHEUNG: And then lastly, obviously, fixed income is not a monolith. Are there specific pockets that you've been watching very closely with these movements up when it comes to [INAUDIBLE] or IG? Where are you kind of seeing a lot of interesting narratives kind of coming out?

GEORGE BORY: So our strategy for this year is twofold. Number one, it's capital protection. Bond yields-- you know, we expected bond yields to move higher. They're moving higher relatively quickly. And as you point out, you know, when bond yields go up, prices go down. So the total return for bonds right now, looking a little vulnerable.

So we want to be very careful as to where we position ourselves. That means very long duration bonds with long maturities will tend to experience a much greater price impact. To offset against that, you can do one of two things. One, shorten your duration-- and we have done that in many of our portfolios.

The second is try to increase your yield. Yields are going up, so to the extent you have cash, you can buy more bonds. That basically increases the income on your portfolio. And that provides more insulation against higher yields.

You can also go down in credit quality. We're at the early stages of a recovery, and the lower ends of the rating spectrum-- high yield, triple-Bs, sort of lower rated structured products as well as municipal bonds-- all tend to do pretty well in a recovering economy. This means there's more cash flow going to bond holders. That works as a credit positive, and you're likely to see credit spread compression to offset some of those bond yields.

So we really like short duration, high yield. We like lower quality munis. We can find pockets of value across the bond market to protect that capital, increase the amount of income investors are earning, and really try and buffer your portfolio to really kind of limit any downside, but really provide as much income generation as we possibly can.

BRIAN CHEUNG: All right. Well, duration and quality-- two good talking points as people head into the market. But again, George Bory, Head of Fixed Income Strategy at Wells Fargo Asset Management, thanks for joining us.