Why global growth is driving long-dated bond yields higher


Mar. 3 2014, Updated 12:14 p.m. ET

A wobbly recovery

The below graph reflects the severity of the 2008 financial crisis, as well as the extent of economic recovery. Despite aggressive monetary and fiscal policy measures since 2008, the recovery has been somewhat wobbly and out of step with the historical pattern of sharp recovery following sharp recession. It’s generally understood that the key structural issue underpinning this less-than-exuberant economic recovery has been a lack of fixed investment in the U.S. economy. This issue is considered in detail in the series US investment: Have capitalists gone on strike?

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This article considers the improving real GDP growth rate in the U.S. economy and the implications for fixed income investors. However, for a more detailed analysis of the U.S. macroeconomic environment supporting this series, please see Must-know 2014 US macro outlook: The crack in the debt ceiling.

Back to trend?

The above graph reflects that, much like Humpty-Dumpty, all the king’s horses and all the king’s men haven’t been able to put the economic Humpty-Dumpty back together again. With enough fiscal glue and monetary grey tape, it might appear that the U.S. economy is “fixed.” After all, post-2010, the economy is growing at a real rate near its long-term average, of around 2.5%, which would be considered an acceptable and sustainable level of growth by the Fed and the White House.

However, this level of growth, while respectable, has come at a fairly significant price—involving the net public-held debt of the USA nearly doubling from 35% to near 70% of GDP. Therein lies the rub. As noted in a prior series, much ado has been made about whether or not this particular level of debt actually has any real long-term economic significance, which could contribute to declining future growth rates.

Economic growth offsets debt growth: Garden-variety Keynesianism

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As we pointed out in an earlier series, it’s entirely possible that the media hype surrounding the U.S. debt had grown out of proportion in relation to the actual size of the debt problem. With recent GDP growth numbers above 3.0%, it would appear to the Obama Administration that the U.S. can grow itself out of this debt, and has already begun to do so.

The big question for investors as well as the White House is, are the current growth rates sustainable without a return to large-scale fiscal stimulus? If current growth rates are in fact sustained in the coming months, it’s likely that the longer-dated bonds and long-duration ETFs, such as TLT, may resume their post-2012 downward trend, which seems to have been initiated by the Federal Reserve tapering announcement.

To see how the U.S. Federal budget deficit is impacting fixed income markets, please see the next article in this series.

For additional analysis related to other key fixed income ETF tickers, please see the related series Fixed income ETFs: Short-duration alternatives for bonds.

Outlook–High Credit Quality & Longer Duration (TLT & BND) versus Lower Credit Quality & Mid Duration (HYG & JNK)

For fixed income investors concerned with rising interest rates and falling bond prices, long-dated (long duration) ETF’s such as the iShares 20+Year Treasury Bond ETF (TLT) may continue to see price declines, should interest rates continue to rise. Note that the TLT ETF has a duration of approximately 16.35 years—roughly twice that of the current 10 Year Treasury Bond at 8.68 years. In contrast to the long-dated TLT, the iShares iBoxx High Yield Corporate Bond ETF, HYG has a much shorter duration of only 3.98 years, as well as exposure to improving commercial credit markets, and may continue to outperform the long duration TLT ETF in a rising rate environment.

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However, it should be noted that the High Yield portfolio of HYG holds roughly 90% of its portfolio in bonds rated BBB3 through B3, with roughly 10% of its portfolio in CCC-rated credit (substantial risks). HYG top holding includes Sprint Corp (S) at 0.56% of the portfolio. The Vanguard Total Bond Market ETF (BND) maintains a duration of 5.5 years, though holds 65.4% of its portfolio in government bonds and 21% of his holdings in AAA-A rated bonds. In comparison to HYG and JNK, the BND ETF is slightly longer in duration (BND 5.5 years versus  HYG 3.98 & JNK 4.20), though is very much concentrated in government and high quality bonds, and will therefore be less impacted by changes in the overall commercial credit markets.

Lastly, for investors looking to maintain yield while gaining exposure to the commercial credit market, an alternative to the iShares HYG, the Barclays High Yield Bond Fund ETF (JNK) offers a similar duration of 4.20 Years versus HYG 3.98 years, holding 84.17% of its portfolio in Corporate Industrial, 7.65% in Corporate Utility, and 7.5% in Corporate Finance-oriented bonds. Like JNK, HYG is also a big fan of Sprint Corp, (S) (0.62%), and First Data Corp.  (0.44%), and also holds CIT Group, CIT (0.26%),Caesars Entertainment, CZR (0.24%), T-Mobile USA, TMUS (0.24%), and Tenet Healthcare, THC (0.24%), Ally Financial, ALLY, (0.23%), and SLM Corporation, SLM, (0.22%).


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