Michael Zeuner: 00:09
Hi everyone. This is Michael Zeuner, one of the managing partners at WE Family Offices. Thanks for listening to the wealth enterprise briefing. I’m joined today by Sam Sudame, our global head of macro, and we’re going to take another look at a topic we’ve been talking about all year, which is the public bond markets and interest rates. And you know, just to set the table, you know, our listeners will remember that at the beginning of the year, rates were higher. There was great anticipation that Fed would bring rates down, but there was also great concern that inflation might re emerge as a result of tariffs, that growth might slow and that that would complicate the Fed’s trajectory and path, and as a result, we saw a lot of volatility in the public bond market. Sam and I have talked before about the relationship between public bond market, the 10 year note, and the Fed, which really controls short term interest rates. Suffice it to say that we’ve talked about this as well. Things have calmed down a little bit in the bond market over the last few months, rates have come down as the Fed has lowered short term rates, but in the last couple of weeks, we’ve seen volatility pick up again in the bond market, and the Fed has been talking about whether it’s lack of data due to the government shutdown or emerging data about inflation still being persistent, that the case for lowering short term rates is not as obvious, perhaps, as it was even A month or two ago. So we’re going to revisit the bond market, talk a little bit about what’s driving the current volatility, and then maybe take a deeper dive into what what really are the key drivers of the public bond markets, the 10 year in particular, and how investors need to be understanding that and position their portfolios as a result of it. So, Sam, welcome. Maybe we could just start with, you know, a little bit of a recent update on what’s really driving the current volatility in the in the public bond market.
Sam Sudame: 02:12
Sure. So we’ve seen a lot of volatility this entire year that we had years at the beginning of the year, we started at a high level. On the 10 year, it started around, let’s say, 4.5% jumped in January, because on the back of this growth optimism. And then, if you remember our conversations back in the spring after the tariffs were announced, we saw in April, the 10 year start to plunge concerns about what that impact would mean for growth. And then we started seeing in the fall, the Fed lowering interest rates. You know, they lowered interest rates in September and October. That took rates down again. And what we’ve really seen this entire year is very high policy uncertainty driving the high volatility in the right markets. And what we’ve seen now is that it started. It’s whipsawed a lot, and it’s because the market is trying to get their hands around that configuration of growth and inflation. What we started seeing recently, when rates have started to come down, not only has the Fed pulled rates down, but there is a concern about a softening of economic growth.
Michael Zeuner: 03:34
Okay, and you know, maybe it would be helpful, and I’m not sure we have talked about this before, but maybe it’d be helpful to take a really big step back and talk about, why is the 10 year treasury yield so important to financial markets? Why do we even bother to sort of focus on this and talk about it
Sam Sudame: 03:54
Sure. You know, the 10 year treasury yield is extremely important for financial markets. It’s used as the discount rate inequities, which are used for equity valuations. It provides the key base rate for fixed income yields, because many fixed income areas, they have a spread above that Treasury rate, and it also helps set borrowing rates. So what we’ve seen is that it provides economic signals regarding growth, inflation, fiscal and monetary policies, you know, all that tends to come together in that 10 year.
Michael Zeuner: 04:36
So, so it’s a little bit like the 10 year is looking at a crystal ball, and if you can interpret what the 10 year is telling you, you might be able to get some insight forward looking into what might happen in capital markets more generally. Okay, so that’s why it’s important. Now, you know, if we think about what the what the tenure is signaling at this moment. What? What’s the crystal ball saying right now, Sam?
Sam Sudame: 05:02
So what it’s saying is that inflation is quite sticky. Growth has softened. There are concerns about US debt to GDP, and in previous calls that we’ve had this year, we talked about this concept called term premium. That is where there’s concerns about us credit worthiness. For instance, as we started seeing us debt to GDP rise, we talked about this a lot last summer, about the one big, beautiful bill and its impact on the deficit, we saw the investors wanting compensation for that higher debt. So as a result, we’ve started seeing these pieces come together on the whole, making rates volatile this year, when we’ve started seeing that tug of war with growth, with inflation, with term premium, with employment, with what is the Fed going to do, and with central bank independence. So all of these factors have come together this year to make a very volatile yield curve.
Michael Zeuner: 06:14
Okay, and we look at that. And in order to really understand the crystal ball, you have to understand how it works, right, and what’s driving it. So when you look at the 10 year, what are the what are the key drivers of what might predict interest rates three months, six months a year from now?
Sam Sudame: 06:32
Sure. So we use many different factors, and we’re looking at those components that drive the 10 year, for instance, real interest rates, inflation, term premium. We also look at Fed policy. What is the Fed doing? We then look at a spread between that short term of what the Fed is doing and what the 10 Year has historically done. And then we look at what is economic growth doing. So we have to look at all of these different factors as inputs into our crystal ball to see what will happen to rates.
Michael Zeuner: 07:11
So when you look at those factors now in the current environment, what does that suggest to you that sort of equilibrium rates might be in these environments with those factors for the 10 year?
Sam Sudame: 07:22
So when we put all of these factors together, well it looks like a reasonable rate, given those current inputs, is about 4% on the 10 year. But then, as you know, the market recalibrates every day, and oftentimes during the day, and when we put in that range because of those different inputs, we can see 4% plus or minus 0.5% in other words, given this environment of the macro economy, a range between three and a half to four and a half percent looks appropriate and kind of hovering around that 4% mark.
Michael Zeuner: 08:01
So we might expect to see short term volatility, right, where maybe the 10 Year goes to 388 or it goes to 410 or 412 right? But within that bound of three and a half to four and a half, what I think you’re suggesting, maybe, is that that’s not really a profound, you know, out of range set of expectations, and that will, you know, in any market, in any capital market, we short, we see short term volatility, but to the extent that either the 10 year falls below that three and a half or goes above that four and a half, that’s when you really have to start taking a look and saying, hey, what’s driving that? That would seem to be much more fundamental than than than short term volatility alone.
Sam Sudame: 08:44
And what can cause going out of that range? As you mentioned, it could be inflation really picking up over the secular horizon, or it could be growth falling off much more than potential that can cause it to break out of that range, either on the top or the bottom, or it could be there becomes a lot of concern about US debt, where new policies are being implemented that’s going to raise that US debt to GDP far more than we expect right now. So when we look at those inputs, is, what is the range of those inputs, and how are they changing?
Michael Zeuner: 09:19
And, you know, I guess I’ll end on a point that we have been emphasizing over and over and over again, which is that even though the Fed is lowering short term rates, investors in the fixed income markets, in the bond market, should not get complacent and take extensive interest rate or duration risk, because there is a scenario for a lot of the factors that we’ve talked about on the call due to a lot of the factors that we talked about on the call. There is a scenario that short rates could come down and long term interest rates could go up well above that four and a half percent, and if. Were the case people holding long dated treasuries, long dated bonds, would get hurt as those long term rates went up. So I guess that takes us back to where we have been, which is really managing interest rate, risk and duration carefully, and staying in what you call the belly of the curve is important maybe, maybe say a little bit more about that before we close.
Sam Sudame: 10:24
So, you know, it is important to note that the Federal Reserve, you know, they meet at their monetary policy meetings, and they set what is called the Fed funds rate they do not control or set the 10 year treasury rate. That 10 year treasury rate is determined by the market, and it’s the market recalibrating it based on all those factors that we mentioned. And when we look at those factors that we mentioned, there’s a lot of interest rate volatility that can happen because of policy. As a result, we don’t want to extend interest rate risk too much in the event that interest rates rise a lot, which is why we like staying in that belly of the curve where one can pick up the yield without taking too much interest rate risk.
Michael Zeuner: 11:12
Okay. Well, thank you, Sam. Please keep an eye on your crystal ball, and we’ll look forward to talking with you in the future. Thanks again.
Sam Sudame: 11:20
Thank you. Michael.
Disclosure: 11:24
The Wealth Enterprise Briefing is for informational and educational purposes only and does not consider the specific investment objectives, financial situation or particular needs of any listener. The information in the briefing is not a recommendation of any security and should not be relied upon as investment legal or tax advice.
