Riding the Curve: A Sprint or a Marathon?

Abby Becker: I’m Abby Becker, consultant relations associate manager here at Allspring Global Investments, and you’re watching On The Trading Desk®. Today, we have a special episode talking about the parallels between the world of running and how investors might consider positioning themselves across the yield curve today to run a successful race. Joining me today is Danny Sarnowski, product specialist for the Plus Fixed Income team here at Allspring. Thanks for being here, Danny.

Danny Sarnowski: It’s a real pleasure. Thanks for having me.

Abby: And now for our audio listeners, it is important to note that Danny and I are currently on the walking path here at our Allspring office in Menomonee Falls, Wisconsin. As I mentioned, we are taking a creative spin on the current landscape in fixed income and our shared passion: running. Can you share with me the experience about your running?

Danny: Sure. Yeah. I’ve been a fairly serious runner, I guess, since about 2010, and I’ve done all sorts of races from 5Ks to fun runs to Ragnar relays and half and full marathons. How about you?

Abby: I started running in about 2015, but I would consider myself an average runner. I do it for fun, the social life, and similar to you, I do all different types of runs, all different lengths at all different paces. It really depends on the day.

Danny: Yeah, that’s great.

Abby: Now, turning to our metaphor, Danny, would you agree that we are seeing many investors treating their yield-curve positioning as a sprint and are focusing heavily on the front end of the curve?

Danny: Well, I think we are seeing a lot of investors move to the front end of the curve. Money market mutual fund assets hit another new all-time high at the end of July of $5.4 trillion. So, whether investors are sort of just focused on the immediate term and thinking of things more as a sprint rather than a longer race or a marathon, you know, maybe. But another running metaphor to use might just be that bond investors or fixed income investors I think trudged up Heartbreak Hill last year and they got to the top of the hill and they’re just tired. And instead of it being all downhill from here, they’re seeing another small hill on the horizon. And many of them are saying, I’m tapping out, I’m taking a walking break, I’m moving to the side, and sort of taking comfort in the front end of the yield curve.

Abby: So, current yields are really attractive for money market investors right now. Is that correct?

Danny: Oh, for sure. Investors on the front of the curve have had to accept very, very low yields for a very long time. In fact, since the Global Financial Crisis, money market mutual fund investors had to accept close to one basis point. That’s 1/100 of 1% of income per year for the benefit of daily liquidity and a very, very low level of volatility. And now, their yields are over 5%. That’s over 500 years’ worth of income at the old level. So, it’s a really, really good time if you’re a cash investor. But if you’re saving for something that’s maybe longer than 12 months out, then this really isn’t a sprint, right? It’s a longer race. And we think that while yields on the front end of the curve are at their highest levels in 20 years, yields across the curve are at multi-year highs, whether it’s 10- or 15-year highs. In fact, the 10-year U.S. Treasury just hit a 16-year high in the last couple of days. So, it’s not just the front end that’s offering a really attractive level of income. It’s the whole curve. And we think that having positions across the curve is an attractive proposition for investors today. We think it compensates for some additional rate volatility and some of the duration risk, but it also provides a good hedge that if the economy starts to soften or if there’s any sort of hiccup in the no-recession scenario, we think that would be a real benefit to investors from a total return standpoint.

Abby: Thank you, Danny. Now, let’s take it a step further. What suggestions might you have for investors still trying to sprint their way to the finish line?

Danny: Yeah, I don’t want to strain the running metaphor, but if you run a race, you know that the race course has different portions, right? Some might be kind of long and low or flat. Some might have rolling hills and some have the big heavy heartbreak sort of hills. And what we think investors need to do is you need to train differently for each portion of the course. And markets are similarly dynamic. So, while we might be seeing a period today where that walking break on the front end of the curve at these very high yields is attractive, that course will evolve and we think investors want to be ready to take advantage of what the course has to offer next. And, so, from our chair, we talk and think about that as riding the curve. And what I mean by that is when you think about yield-curve positioning, it’s certainly keeping a portion on the very front end and taking advantage of these high, high yields but then diversifying exposures across the curve so that as the yield curve normalizes over time, investors get the benefit of that normalization from a few different periods, a few different times, as opposed to waiting and making one big bet on one other portion of the race course to sort of ultimately determine your success. So, I think that diversified exposure along the curve is a good recipe for a longer race as opposed to just training and focusing on one portion of the course.

Abby: With the time we have left, can you give our listeners any insight as to what type of conditions we might be facing with the months to come. As inflation is rolling over in areas and prices that are continuing to moderate, could the weather be clearing up for investors to really be back in the race or should we conserve our energy for any surprises ahead?

Danny: Well, we do think that the course is going to evolve here. From the rate standpoint, we think the mentality will shift from how high is the Fed (Federal Reserve) going to take rates to how long will they keep them elevated. And we think that ultimately the cost of debt, the higher burden that that monetary policy tightening has placed on the economy, will start to roll through and we’ll see investors and borrowers have to make trade-offs in what they can or can’t afford. We’re going to add student loan repayments to millions of borrowers. And more stress is growing. It doesn’t mean that things need to end poorly or that we need to see some sort of massive recession. But we just think that things are likely to get more challenging and that there probably will be more winners and losers from a credit standpoint and that individual security selection and diversification are going to be really important to running a good race from this point forward. Because I don’t think we can count on any one strong tailwind sort of taking you across the finish line. I think it’s really about, again, preparing ahead of time, training for all those different parts of the race and then putting them into practice across the portfolio. So, for us, that’s riding the curve. It’s having some duration and it’s being a little bit more cautious on credit because as those winners and losers emerge, we think we’ll get better relative values that we can take advantage of at a future time.

Abby: Great. Thank you for being with us, Danny, and sharing your insights with us today.

Danny: My pleasure. Thanks for having me.

Abby: And thank you to our listeners and viewers for tuning into On The Trading Desk®.

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Disclosure: Diversification does not ensure or guarantee better performance and cannot eliminate the risk of investment losses.