Bond Market Perspectives | Week of August 18, 2014

posted 8/21/2014 in Investments

Highlights

  • Geopolitical risks powered bonds to another weekly gain, but historically such gains have been short-lived and given way to other fundamental drivers.
  • Low volume summer trading may keep bond yields pinned near year-to-date lows over the near term.

Geopolitics & Bonds

Bonds posted another weekly gain, due mostly to late week strength on the latest round of
geopolitical fears. News of a Ukrainian attack on a Russian convoy helped spark a strong rally on
Friday, August 15, 2014, pushing 10- and 30-year Treasury yields to new year-to-date lows before a
modest reversal began on Monday, August 18, 2014.

A string of geopolitical events has helped bonds recently, from lingering tensions in Ukraine-Russia
to renewed conflict in the Middle East both in Gaza and Iraq. Violence that results from such events creates uncertainty and can negatively impact investor sentiment. Heightened uncertainty in turn creates demand for high-quality assets and Treasuries are at the top of many investors' shopping lists.

Geopolitics has helped push Treasury prices higher and yields lower on a few occasions in recent
years.

  • Egyptian Revolution 2011 -- The fall of Egypt's government in early February 2011 was among the more notable events of the "Arab Spring." Treasury prices rose following the overthrow of the Egyptian government with the 10-year Treasury yield falling from a peak of 3.75% down to 3.40% at the start of March 2011.
  • Syria 2013 -- President Obama's authorization to use air strikes at the end of August 2013 and early September 2013 helped bring about the end of the taper tantrum sell-off in the bond market as the 10-year Treasury yield approached 3.0%. The escalation of the Syrian conflict helped attract demand to high-quality bonds.
  • Ukraine 2014 -- Russia's annexation of Crimea in late February 2014 gave Treasuries a lift as fears over a greater conflict increased. The 10-year Treasury yield decreased from 2.75% to 2.60% following Russia's invasion.

In some cases higher oil prices accompany geopolitical conflicts and can create economic concerns.

Higher energy prices can be a potential drag on the global economy, which can help support bond
prices. This was not the case last week as oil prices continued their recent decline but the price has been above $100/barrel for much of 2014 and played a role in bond strength this year.

Not the Only Driver However, geopolitical events are usually accompanied by other market forces and are not the sole driver of bond prices. In the examples above, the move in yields proved short lived as fundamental forces took over as the main driver of bond prices. In 2011, European debt fears provided support to Treasuries for much of the year. In 2013, the taper tantrum created notably higher yields and cheaper bond valuations, which helped draw in investors.

Similarly, in 2014 multiple factors have played a role in domestic bond strength, not just renewed
geopolitical fears. The initial lift to bond prices from the Crimean Crisis faded, but weak domestic economic data during the first quarter of 2014 helped support bonds. More recently, weak economic data in Europe and worries over the potential economic impact of sanctions has helped support European government bond prices.


European Record Lows

European government bond yields fell to new record lows last week as a result of economic and
geopolitical concerns. The 10-year German Bund yield fell below the 1.0% barrier, closing the week at 0.95% before bouncing back to 1.0% in early trading Monday, August 18, 2014. The decline in competing high-quality European government bond yields has made U.S. Treasuries look more
attractive by comparison. The drop helped the U.S. 10-year fall to fresh 2014 lows [Figure 1].

Yields on 10-year Spanish and Italian government bonds sit nearly level with comparable Treasuries and make Treasuries more attractive to global investors.

Strong Auction Demand

U.S. government auctions of 10- and 30- year Treasuries saw strong demand last week despite yields hovering near year-to-date lows. Robust demand for more interest rate sensitive longer-term debt is a vote of confidence on the market, and bodes well for Treasuries holding recent gains over the near term. This may be particularly true due to lower volume summer trading and investors placing an emphasis on safety and liquidity over the short term.


Fed Focus

The coming week brings the release of the minutes of the last Federal Reserve (Fed) meeting as well as the Fed's annual Jackson Hole monetary policy conference. Both will be scrutinized for more details of the Fed's exit plan for gradually raising interest rates and removing excess cash from the banking system. In the past, this conference has provided insights into the path of future Fed actions but a market-friendly tone is expected. Fed Chair Janet Yellen's keynote speech on Friday, August 22, 2014 will focus on labor market dynamics, which remains unsatisfactory according to several measures she has highlighted, and a reason to take a go slow approach. The Fed's September 17, 2014 meeting potentially looms larger as it includes updated economic forecasts and a press conference, and may provide a definitive update on the Fed's exit strategy.

Conclusion

The bond market's pricing continues to reflect expectations that the Fed will take longer to raise
interest rates and go at a slower pace once rate hikes begin compared to the Fed's own guidance.
Indications from the Fed, either this week or at the upcoming September 17 Fed meeting, that itremains on course to raise interest rates a year from now may jar bond yields higher. In our view, such an indication is more likely to come at the September Fed meeting, if it comes at all, and in the meantime lingering uncertainty, geopolitical or economic, may continue to support high-quality bond prices in August despite expensive valuations.


IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to
provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Index performance is not indicative of the performance of any investment.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields
will decline as interest rates rise, and bonds are subject to availability and change in price.
This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent
investment advisor, please note that LPL Financial is not an affiliate of and makes no
representation with respect to such entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not
Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Tracking #1-299993 (Exp. 08/15)

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

The financial consultants of Wealth Management are registered representatives with and Securities are offered through LPL Financial. Member FINRA/SIPC. Insurance products offered through LPL Financial or its licensed affiliates.

Not FDIC/NCUA Insured Not Bank/Credit Union
Guaranteed May Lose Value
Not Insured by any Federal Government Agency Not a Bank Deposit

This newsletter was created using Newsletter OnDemand, powered by Wealth Management Systems Inc. 

Blog and News