Where’s the 10-year U.S. Treasury yield going?
This is the most common question I get from both institutional and advisor clients. It’s a question we’d all like to know the answer to—and one you might expect a bond manager like me to answer. It’s like asking a stock picker where the S&P 500® Index is going to be in six months. The trouble is that these are difficult questions to answer—or at least to answer correctly. Even the most educated prognosticators—the Ph.D. economists—have a rather poor record in predicting 10-year bond movements. Perhaps you trust the collective wisdom of the free markets more than trained economists. You’d find no better record here, either. The market has priced in a rising 10-year rate every single quarter for the last 30 years. But 30 years ago, the 10-year was over 9% versus approximately 2.23% today.1
It would take a great deal of hubris for me, or anyone else, to believe that we can produce great performance simply by virtue of predicting the direction of long-term interest rates. I would never claim to have such a crystal ball. Thankfully, that’s not necessary for translating an outlook into returns in the interest rate market, because investing is different than predicting. With the right capabilities, it is possible to weaponize our macro views to produce better returns via interest rate positioning in a bond portfolio. But it requires two things:
- A broader focus than just predicting a single rate.
- A great deal of discipline in the face of doubt.
When it comes to weaponizing interest rate outlooks, investors need to focus on three principles. They need to respect the relative certainty of the outlook at each principal level. Finally, they need to allocate active risk accordingly.
Principal one: Take the long view
First and foremost, investors should remember that long wins in the long run. It’s why bonds exist as an investing asset class to begin with. Over the long-term, investors should be—and generally are—paid to take interest-rate risk. And we believe the more risk they take, the more they get paid over the long run. If you know nothing about the market environment or are highly uncertain about what you think you know, we believe your default position should be to go long on interest-rate risk in your bond portfolios.