What is shaking up US bond auctions?

Published on 8 March 2021

In the US, growth and inflation expectations with additional Government stimulus will increase demand on goods and services, while rising rates and positive rate expectations are making the yield on new bonds more attractive.

While participation in last Friday’s US Government bond auction was at record lows, the impact on other bonds will depend on their sensitivity, and typically their rating as investment grade / high yield.

For investment managers allocation to rate sensitive bonds can be problematic, as can passive strategies or restrictive mandates which limit the responsiveness of a portfolio manager. Jeff Rosencranz, fixed income portfolio manager at Shelton Capital Management outlines his approach to managing these risks.

Dan Barnes Welcome to in Primary Markets TV – your update on newly issued secuties in the fixed income and equity space. I’m Dan Barnes. Joining me today is Jeff Rosencranz, fixed income portfolio manager at Shelton Capital Management. We’re going to be discussing what’s impacting new issues in the US fixed income markets. Jeff, welcome to the show.

Jeff Rosencranz Great to be here. Dan, thanks for having me.

Dan Barnes So tell us what’s shaking up the US bond markets right now?

Jeff Rosencranz Well, growth and inflation expectations are really starting to pick up. We’ve had a huge amount of savings that’s accumulated in the US that’s about to be unleashed into the economy. And we’ve had stimulus. We’re going to get more stimulus as soon as this weekend and then possibly an infrastructure bill in the near future. And so a lot of demand is going to start chasing goods and services. At the same time, you have supply constraints all around the world, shipping and logistics delays, lack of skilled workforce. So you’re going to have a bit of a squeeze, if you will, on demand versus supply that I think will push up prices and the markets are starting to price that in.

Dan Barnes Last week we saw, I think, the lowest ever uptake for an issuance of US government bonds, which is really interesting. Can you tell us how do you see new issues being affected by factors you mentioned and how are bonds already issued being affected?

Jeff Rosencranz So, I think differentiating between the investment grade market and the high yield market is important. Investment grade traders and portfolio managers are sort of used to high dollar prices, low dollar prices, and they’re pretty indifferent. And this big rate move, you’ve got a bunch of high quality investment grade bonds now trading in the 70s and the 80s, and they’re OK with that. And in fact, the added convexity of some of those bonds is actually becoming more attractive. On the flip side in high yield, when newly issued bonds with lower coupons trade down or trade in the hole, they get a little bit of a taint to them and it’s hard to shake that off. And so a lot of times a new issue in high yield that trades down, that stigma will stay with it. And people might prefer more seasoned bonds to those.

Dan Barnes In terms of the rates at the moment, where abouts are we and what are the expectations for interest rate changes? And how does that impact both new and existing portfolios?

Jeff Rosencranz 10 year is now just under 1.5%, and that’s up significantly on a year. Strategists and sell-side analysts have been continuously moving up their targets for year end. Goldman Sachs, just yesterday moved to 1.9%. We’ve been out in front of this. We see the 10 year and the long bond yields continuing to go up as all this pent up demand is injected into the economy. The growth is already starting to pick up and we see that continuing. So further rate increases ahead, which is going to have a significant impact on fixed income portfolios.

Dan Barnes What is the potential impact on the portfolios and how can portfolios be protected against any risks that’s creating?

Jeff Rosencranz One of the reasons we find ourselves so impacted is the duration of the AG and the investment grade, corporate bond markets are at multi-year highs, so our sensitivity to these changes in interest rates has never been greater. There’s a big difference between rates, say, going from 2.5 to 3-5% versus what we’re seeing now going from less than 1% to 1.5% and higher. There’s been a big shift in dollars in fixed income from active management to passive. And that can really exacerbate these changes because the managers don’t have the flexibility in a passive strategy to change their weightings iand their allocations. So it’s a great time for active fixed income management, because you can do some of the things that you mentioned.

You can play defense and you can play offense. Adding hedges, if you’re able to do that by your mandate, you can shorten duration, but really all you’re doing there is looking to lose less money. And so some of the things that we’ve been doing are reducing or eliminating allocations to more rate sensitive instruments, investment grade bonds. BB, high yield bonds; they’re really rate sensitive and changing or moving allocations to instruments and sectors that are going to benefit from this big increase in growth and the reopening of the economy, so gaming, lodging, leisure, cruise lines, energy, cyclicals, basic materials. If you have the ability to reduce your interest rate sensitivity and increase your credit sensitivity, I think that’s how you not just play defense but actually play offense and generate returns in this market.

Dan Barnes Excellent. Jeff, thank you so much.

Jeff Rosencranz My pleasure.