US Data Improve But Yields Continue Downward

The yield on the ten-year Treasury note dropped to 2.47% briefly last week. Two factors should, in theory, cause yields to go up, not down: 1) improving US economic data and 2) withdrawal of extraordinary stimulus. US jobs data and inflation both continue to point toward robust economic growth and investors widely believe the low (0.10% annualized) real first-quarter GDP growth was a product of bad weather. When economic prospects improve, demand for money increases and lenders can impose higher rates on borrowers. At the same time, withdrawal of extraordinary stimulus (purchasing of Treasury bonds by the Federal Reserve), should increase the total of amount of net Treasury note issuance, leading investors to demand a higher yield on investment to absorb the additional supply. Combine these two factors and yields should go up, not down.  The apparent cause of the drop in ten-year yields last week was notification from the European Central Bank of additional “accommodative measure” (which is the European version of America’s “extraordinary stimulus”). The logic goes that additional accommodation means Europe is actually on shakier footing than previously believed and it thus makes sense for investors to buy higher yielding, safer assets (ie. US Treasuries). Increased demand for Treasuries means lower yields. Voila! But it is not that simple. Rather than trying to make reactionary short-term timing decisions, we instead focus on longer-term trends to manage risk and outperform over the long term. To manage risk, we break down portfolio exposure into categories like interest-rate, credit and concentration risk and we align those exposures with client objectives. The longer-term trend, as far as US data are concerned, is upward and with improving data we still expect yields to be higher one year and two years from now.