In this piece, we take key points from our firm's most recent Bond Policy Meeting and share them with our readers. Hopefully, this piece will provide some insight into the economy and fixed income markets and give you a sense of how our team is thinking about recent trends and developments.
Crawford Bond Policy
- We take the Fed at their word and believe they are now solidly in wait-and-see mode. This applies to inflation and labor market data, in addition to the implementation of Trump administration policy.
- We believe rate policy remains in “easing” mode but is comfortably (their assessment) on pause for now. This will keep the short-end of the curve tethered in a narrow band to the current Fed Funds rate.
- Longer-term interest rates are subject to a higher level of volatility, however, as the market digests policy implementation and economic data, projects the effect on interest rates, and demands compensation for unknowns.
- We view the November election results as a catalyst for higher interest rates.
- Inflation pressures from tariff and deportation policy, and the impact of tax reduction without offsetting expense reduction, threaten debt and deficit management.
- Inflation keeps the Fed from easing policy, and the market demands term premium to compensate for unknowns.
- Consequently, we have made efforts to soften our duration stance to reduce market risk exposure and position for the ability to participate through maturity extension if long-term rates move meaningfully higher.
- Despite the unknowns associated with Trump policy implementation, we continue to believe the credit backdrop remains very constructive for the Corporate and Municipal bond sectors, supported fundamentally by a strong economy, and technically from continued healthy investor demand at attractive absolute yields.
Treasury Yields as of 1/30/2025 (Post-Fed Meeting)
- Nominal U.S. Treasury security yields fell between our December 2024 and January 2025 Bond Policy meetings. But the full story of recent bond market performance is tied to the trend that began shortly after the September Fed meeting and culminated with peak yields in mid-January.
- Economic data supported the trend in higher yields over the course of the fourth quarter and turn of the new year. Payroll reports in three of the past four months (excepting October for storm effects) paint a picture of labor market strength. Recent inflation data demonstrated modest improvement, but since last August, inflation has been consistently above the Fed’s 2% target.
- Outside of economic data, the other recent bond market performance driver has been the re-election of Donald Trump and congressional "red wave."
- The promise of a pro-growth policy agenda, combined with tariffs and immigrant deportation, has elevated yields to levels last seen in October 2023. At that time, a similar combination of economic, inflation, deficit spending, and higher-for-longer Fed policy expectations pushed yields to pre-2008 financial crisis levels.
- The threat is for interest rates to move higher if inflation forces the Fed to keep policy on hold and the market perceives a lack of government debt and deficit management, resulting in higher yield term premium.
- One worrisome inflation indicator is the recent ISM Services Prices Paid Index result, which is typically a strong leading indicator of the trend in Supercore CPI and PCE inflation indexes.
Term Premium
- Term Premium is defined by the Federal Reserve as “The compensation investors require for bearing the risk that interest rates may change over the life of a bond.”
- There are several models that attempt to quantify Term Premium, but it is ultimately what remains after known constituents are subtracted from a nominal yield. For example:
- In other words, it is risk premium demanded for a lack of inflation and real rate predictability.
- As demonstrated in the chart above, Term Premium has become an important part of the attribution conversation for yield movement since the beginning of the fourth quarter in 2024.
- As of the recent yield peak of 4.79% on 1/14/25, the 10-Year Treasury yield had increased 101 basis points since 9/30/24. Term Premium accounted for over 60% of the 10-Year yield increase.
- Term Premium has become a significant component in attributing the factors driving nominal yield movement. This will likely continue to be the case with national debt and deficit management getting more attention from the market.
Disclosures:
Crawford Investment Counsel (“Crawford”) is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Crawford, including our investment strategies, fees, and objectives, can be found in our Form ADV Part 2and/or Form CRS, which is available upon request.
The opinions expressed are those of Crawford. The opinions referenced are as of the date of the commentary and are subject to change, without notice, due to changes in the market or economic conditions and may not necessarily come to pass. There is no guarantee of the future performance of any Crawford portfolio. Crawford reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.
Material presented has been derived from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed.
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