September 15, 2017
“An investment in knowledge pays the best interest.” – Ben Franklin
Rumor has it that whenever the Founding Father was faced with making a key decision, he’d divide a piece of paper in two. On one side, he’d list the reasons for taking a course of action and on the other side, those against. Let’s apply a form of this strategy to assess whether the current bull market—history’s second-longest and second-strongest—will continue.
Brian Nick, Chief Investment Strategist, TIAA Investments
Hopes for pro-growth fiscal policy from Washington, D.C., are down to a flicker. December is shaping up to be a busy month for lawmakers, with showdowns likely over the budget, immigration, and other hotly debated topics. Will they also be able to draft and pass a robust tax bill, or other business-friendly measures, by year-end? Recent experience has told us to expect nothing from Washington as a base case, and it seems prudent to adhere to this rule until it is contradicted.
The week’s risk-on mood hurt demand for U.S. Treasuries and other investment-grade fixed-income assets. The yield on the bellwether 10-year U.S. Treasury, which moves in the opposite direction as its price, moved up from its recent 10-month low of 2.05% to close at 2.20% on September 15. High-yield bonds, though, returned 0.21% for the week through September 14, bringing their year-to- date gain to 6.5%. We believe higher-quality high-yield bonds offer good value, as do similarly rated floating-rate loans.
In a light week for U.S. data releases, gauges of inflation and consumer spending were the most revealing. Among the reports:
Through quantitative easing (QE), the Fed expanded its portfolio (from $800 billion to $4.5 trillion) by purchasing $3.7 trillion in Treasuries and mortgage-backed securities from 2008-2014. Since then, the Fed has maintained its balance sheet size by rolling over maturing securities and reinvesting their proceeds.On September 20, the Fed is expected to announce a balance-sheet reduction plan similar to the “go-slow” approach Yellen laid out in June. Under this scenario, the Fed will initially allow up to $10 billion of bonds to mature each month, with the cap incrementally rising to $50 billion until the Fed has reduced its balance sheet to its desired target. Estimates for the size of the final, slimmed-down portfolio range from under $2 trillion to more than $3 trillion. Even at this higher end, the Fed will still roll off an unprecedented $1.5 trillion in bonds.
To the extent that QE’s cumulative effect was to push down long-term interest rates relative to short-term rates, this program should have the opposite effect. Treasury yields will be higher than they would have been had the Fed not decided to taper its holdings. But this process will unfold over several years, so we expect any rise in yields to also be gradual.
© 2017 Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA), 730 Third Avenue, New York, NY 10017