Investors have seen a great deal of volatility in U.S. treasuries over the past six months. Early in the year, the combination of recessionary data stateside as well as quantitative easing (QE) measures in Europe helped propel demand for U.S. sovereign debt. Then came the massive unwind, alongside Fed hints at upcoming rate hikes; treasury yields spiked. More recently, the Greece default and the market meltdown in China gave treasuries their groove back.
At present, the 10-year yield (2.25%) sits pretty darn close to where it sat at the start of 2015. If I had to project where that yield would be at the end of the year, I’d tell you that it might move up, down and around, but that it would ultimately be near where it is today. I feel the same way about the greenback. In essence, I anticipate that the U.S. dollar may jump around, but that it will not move substantially higher or lower over the next 6 months. In other words, irrespective of financial system shocks, geopolitical uncertainty or central banker gamesmanship, both the buck and the 10-year may be directionless.
If I see little reason to invest in the greenback or bet against it, if I do not see value in adding meaningfully to treasuries in a portfolio or betting against them, why discuss U.S. sovereign debt or the U.S. currency at all? Primarily, I have noticed a trend toward risk aversion that may adversely affect U.S. stocks.
Take a look at the price ratio between treasuries and crossover corporates – U.S. company bonds that span the lowest end of investment grade (Baa) universe through the highest-rated “junk” (Ba) arena. One can do this by comparing iShares 7-10 Year Treasury (IEF) with iShares Baa-Ba Corporate (QLTB). In essence, since March, there have been higher lows in the price ratio and a consistent ability for IEF:QLTB to maintain above its long-term trendline. Moreover, the momentum in IEF:QLTB indicates a widening in credit spreads such that investors may be increasingly turning toward the return of capital over a return on capital.
The credit spread evidence is hardly an indication of blood in the streets of Pamplona. Nevertheless, the iShares MSCI Spain Index ETF (EWP) sits near 2015 lows; its current price is well below a long-term 200-day moving average. Indeed, investors may be doubting the ability of the European Central Bank (ECB) to find a path forward. It is one thing to express a desire to “do whatever it takes” to preserve the euro-zone. It is another thing to keep debt-fueled excesses from fracturing alliances.
Granted, the People’s Bank of China (PBOC) may eventually contain the fallout from the lightning quick collapse of Chinese equities in Shanghai. And central bankers may yet find a way to kick the toxic debt can down a European cobblestone path; that is, a disorderly “Grexit” for Greece is not an absolute certainty. Even the upswing in S&P 500 VIX Volatility (VIX) is merely a sign that folks are willing to pay a little bit more for index option protection than they were a few weeks earlier.