England is a country rich in soccer tradition and boasting the English Premiere League, the world’s top club league. The U.S.A. is allegedly always one step away from ‘soccer becoming huge,’ but Major League Soccer does not get much domestic attention, in favor of the multi-billion dollar National Football League. However, the United States’ World Cup win against Ghana had the most U.S. viewers ever for a match (11 million), so it is moving in the right direction. Just 100 years ago, boxing and horse racing were the most popular sports in the country. With concussions getting more attention which could result in major lawsuits from former NFL players and popularity higher than ever, maybe American football is at its peak?
What the U.S.A. does have in common with the U.K. are similar financial markets. Note how closely the stock markets tracked each other since 2000. In 2013, U.S. markets took a big step ahead.
Both the U.K. and the U.S. had housing bubbles over the last decade, except that the U.K. is back to new highs. The U.S. meanwhile has seen many areas of the country recover, yet it is still below the 2006 highs at an aggregate level.
Because of the hot housing market, the Bank of England signaled intentions to raise interest rates sooner in 2015. Expectations of a rate hike moved earlier from May to February 2015, resulting in the two-year U.K. Gilt yield rising and the sharpest move since 2010.
Even interest rates seem to move in tandem for the countries. The broad moves in two-year yield followed each other closely, yet the difference between the two today is quite wide. Some consider the Bank of England to be a little ahead of the Federal Reserve, so our short-dated bonds yield could play catch up. In addition, the below chart shows the yield spread between the 10-year and five-year bonds for each country. This tracked closely the last several years.
If the five-year bond yield would rise to meet the 10-year, the spread could continue to fall. While it is a ways off, if the spread were to fall to zero, it would signal a very high risk of recession, just as it provided a warning shot across the bow in 2000 prior to the 2001 recession, and in 2006, prior to the 2008-09 recession.
This has implications for short-term bond funds, and particularly holdings in the two- to five-year area of the interest rate curve which includes some intermediate municipal bonds. Given these strategies take anywhere from two to five years of duration risk, assuming a 1% rise in interest rates, all things equal, bond prices would fall 2-5%. Yields on these strategies range from only 0.5% to 2%, so this does not seem to compensate for the interest rate risk. Our managers are looking at barbell bond strategies, pairing longer dated bonds and very short duration positions (often floating), while keeping credit quality high. Examining yields on bond portfolios is important today, as it may not provide the ballast to the total portfolio as it has in the past.
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