June 6, 2018 | By Hank Cunningham
The uptrend in bond yields should resume which means an unattractive risk/reward for longer-dated bonds. Indeed, this is happening as the U.S. ten-year has tacked on 13 basis points since month-end and is just short of 3%.
Short-term yields in North America will likely continue to rise as the Federal Reserve has left little doubt that it will move the Fed Funds Rate closer to “normal.” The U.S. economy continues to exhibit strength in most sectors, as witness the most recent employment report. Inflation is also showing early signs of modest acceleration. At the margin, the likelihood of the ECB ending its quantitative easing bond purchase program will exert upward pressure on North American bond yields.
The strength of the U.S. economy, combined with heavy issuance of U.S. Treasury bills, notes and bonds plus the monthly runoff from the Fed’s balance sheet, should push bond yields back over 3% with a 3.25% rate likely.
The odds of a recession occurring in the next two years, while considered low by consensus, are increasing as a result of higher corporate leverage and rising interest rates and bond yields. Thus, while credit markets, both investment-grade and high yield, are healthy at present, there is the growing possibility of deterioration in corporate credit health.