Rising Up, But Not All at Once Why Long-Term Rates are Rising as Short-Term Remain Near-Zero
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Why Long-Term Rates are Rising as Short-Term Remain Near-Zero
Most expect the domestic economy to surge as states re-open and as the result of multiple rounds of fiscal stimulus. Simultaneously, inflation expectations are rising, as are bond yields. Yet, despite the headlines about rising rates, investors in the short end of the yield curve aren’t seeing the same increase as their long-term counterparts. Long-term rates have been rising, while short-term remain anchored near-zero. Let’s examine some of the factors driving this.
The Current Macroeconomic Backdrop Sets the Stage
Economists are currently forecasting U.S. gross domestic product (GDP) to exceed 6% in 2021. The stock market has looked favorably upon these expectations, as evidenced by the performance of major indices. Of course, the economy, stock market and credit markets have also benefitted from monetary and fiscal stimulus. The Federal Reserve (Fed) cut rates to near zero in 2020, created numerous programs to support various sectors of the bond market and pumped more than $3 trillion of liquidity into financial markets through securities purchases.
Congress also initiated unprecedented economic stimulus packages– the CARES Act, a $900 billion stimulus package at the end of 2020 and the American Rescue Plan Act. Together, these provided: payments to households, aid to state/local governments, increased unemployment benefits, forgivable loans to small businesses, and billions in funding to fight the COVID-19 pandemic. So, it’s not particularly surprising that inflation expectations are increasing.
Long-Term Rates are on the Rise. Short-Term, Not So Much
The yield on the 10-year Treasury note has risen from a low of 0.52% in August 2020 to 1.69% as of March 22, 2021. Over that same period, the yield on 2-year Treasury notes has stayed between 0.10% and 0.20%. Thus, long-term rates have surged, but yields on shorter-term investments have remained low.
As far as yields on money market funds and local government investment pools (LGIPs): Very short-term rates have fallen to almost zero, and on occasion, have been negative! Simply, though yields on longer-term investments are rising, short-term yields have fallen.
Federal Reserve Policy is the Driving Force Behind Low Shorter-Term Yields
The Federal Open Market Committee (FOMC) target range for the federal funds rate is currently 0% to 0.25%. By targeting near-zero rates, the Fed policy acts as an anchor for short-term rates. That anchor weighs down yields on even 2-year investments because the Fed’s own outlook is for near-zero rates to persist. The Fed’s latest “dot plot” (March 17, 2021) shows that FOMC participants’ assessments of appropriate monetary policy indicate near-zero short-term rates through 2023 (although seven of the 18 participants view a slightly higher level as appropriate at that time).
Further, the Fed has reaffirmed its commitment to remain accommodative, at least until “labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment” and inflation also reaches the Fed’s 2% average target.
With unemployment at 6.2%, maximum employment certainly seems well off into the future. And, given the Fed’s revised stance on inflation — to target 2% over time, but allow inflation “to moderately exceed 2% for some time” — any liftoff from near-zero rates is likely down the road. Moreover, while long-term Treasury yields are rising, shorter-term Treasury yields, are not likely to move up anytime soon.
What about commercial paper and bank certificate of deposits (CDs); don’t they have higher yields?
Yes, but liquidity in the short-term markets has created insatiable demand, driving yield spreads lower. Simultaneously, many traditional borrowers have used the low rates to lock up longer-term borrowing, so the issuance of short-term products has been constrained. In other words, there is just too much cash chasing few investment opportunities. Great news for borrowers; difficult for LGIP investors.
What is PFM Asset Management LLC (PFM) doing to combat this?
- Carefully managing the weighted average maturity of our LGIPs as we seek to capture value while maintaining a primary emphasis on safety and liquidity,
- Casting a wide net and diligently canvassing the market every day for relative value opportunities among various sectors and issuers,
- Staying committed to our longstanding credit philosophy that emphasizes safety.
PFM recognizes today’s market challenges. We’ve been here before and we know what to do. We remain committed to meeting your safety and liquidity needs while seeking competitive yields in this challenging environment.
For more information about PFM, or any information in this article, please contact Trish Oppeau directly at 314-619-1792 / oppeaut@pfm.com or Nick Kenny at 573-529-9245 / kennyn@pfm.com.
PFM is the marketing name for a group of affiliated companies providing a range of services. All services are provided through separate agreements with each company. This material is for general information purposes only and is not intended to provide specific advice or a specific recommendation. Investment advisory services are provided by PFM Asset Management LLC which is registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940. The information contained is not an offer to purchase or sell any securities. Applicable regulatory information is available upon request. For more information regarding PFM’s services or entities, please visit www.pfm.com.
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