The second quarter of 2018 revealed little news in the bond market, as the generally range-bound trading that marked previous quarters remained in place. On May 11th, the yield on the 10-year U.S. Treasury bond reached 3.11 percent, and it appeared that interest rates were headed higher on the back of a surging U.S. economy, but as in past episodes, the benchmark yield fell back to 2.78 percent by the end of May.

We believe the 3 percent level will eventually hold, and is likely just a waystation on the road to higher rates. The U.S. economy continues to be strong enough to handle more expensive money, and once investors get comfortable with 3 percent, we would expect the next landing spot to be 3.25 percent. There are headwinds preventing this from happening in the short term, however. In order of relative importance, they are: tariff/trade issues, Italy/European Union (EU) concerns, and emerging market worries.

Trade issues are at the forefront right now, after ramping up markedly in June. Not only did the Trump administration slap tariffs on Chinese products, but on goods from the EU, Canada and Mexico as well. These efforts to fix (what many believe are) unfair trading terms for the U.S., will likely have negative ramifications for future economic growth. The trouble is, no one knows how severe they might be. Key question: Will the growth gained from the December tax cuts be offset by tariffs? This uncertainty helped to push long-term interest rates back down in late May after their early spring increase.

Next, just like the arrival of robins every spring, another EU participant made noises about exiting the alliance during the quarter. This time around it was Italy. Unlike Greece or Portugal, Ita-LEAVE would be a major blow to the EU, as Italy is arguably the second most important economic contributor after Germany. Italy’s banks remain burdened with billions of Euros in bad loans. They’re also badly undercapitalized, even after years of money printing by the European Central Bank. The Italian government believes the EU should absorb a large portion of any losses, and, of course, other EU participants don’t see it that way. Unfortunately, the precedent set with Greece’s bailout puts the EU in a tough position. It can’t very well turn its back on an important partner. Uncertainty over the eventual outcome contributed to a flight to the U.S. Treasury market during the quarter, as money fled the Eurozone and purchased a (perceived) safer asset.

These tariff and EU issues also catalyzed worries in several emerging markets (EM) during the quarter. Brazil, Turkey and Indonesia were the poster children for this EM angst. Their economies owe too much dollar-denominated debt, and are not strong enough to absorb a pronounced slowdown in global growth. Any interruption in bullish trends therefore spells trouble, and credit default spreads widened and currencies plunged for these nations as a result.

Nathan Boxx, Bradley Newman, Jason Seltzer

Impact of COVID 19 on Healthcare Costs

Wed, Oct 14, 2020 12:30 PM – 1:30 PM EDT

Find Out More & Register 


Savvy Social Security Planning: Basic Rules and Claiming Strategies

Thu, Oct 15, 2020 12:30 PM – 1:30 PM EDT

Find Out More & Register