The debt ceiling raise is now solidly in the past, and the bond market is now grappling with twin liquidity drags (Fed balance sheet reduction and a Treasury cash raise). For the near-term (next few months), this likely means longer duration bonds should find marginally less bid today, vs 3 weeks ago, with mortgage-backed securities (MBS)  feeling a pinch more pain than treasuries and corporates. For the more intermediate term (3 months or longer), we see the liquidity drain working to raise the floor on yields if and when the economy heads into a recession. Typically, during a recession, 10-year Treasury yields might fall 250 bps or more from peak before the recession to trough during recession. For this cycle, assuming a peak 10-year yield of about 4.3%, we’ll say that would bring yields down to about 2.00%. But the impact of higher Treasury supply in the next 18 to 24 months due to the debt ceiling raise, along with higher inflation this cycle vs prior cycles, likely means that 10-year yields have less room to fall. How much less? We expect 10-year yields to bottom above 3.00% this cycle, before resuming their march higher.

Source: Bloomberg LLC and Strategas Securities, as June 7, 2023

So, does this make us want to sell bonds? No, not exactly. That’s because recession risks are also rising, in part due to the fiscal drag that comes with the debt ceiling raise. We expect close to 0.50% fiscal drag as a percent of GDP over the next 18 to 24 months. That’s enough economic headwinds, when combined with the lagged effects of tightening monetary policy, to push the U.S. economy into a shallow recession by the end of this year. If and when the labor market begins to falter, we would expect Treasuries, and MBS, to temporarily reverse their underperformance from this year’s liquidity drain and outperform equities and U.S. credit along the way. Aiding this Treasury outperformance could also be the end of Fed balance sheet reduction, though we don’t anticipate another round of quantatative easing (QE) this year or next.

This mixed picture for bonds, depending on your time horizon, makes active fixed income management critical over the next few years. Strategies that deploy active duration and credit risk management around these key turning points in the business/credit cycle, should have a decided advantage over the passive fixed income strategies that performed so well during the era of QE.

At Strategas Asset Management, we have developed two active strategies which we believe are positioned to effectively take advantage of the above conditions we feel are likely to develop as Treasury supply increases and liquidity decreases post the debt ceiling deal.  The Strategas Core Fixed Income Strategy is an actively managed portfolio of multisector bonds seeking to maximize returns while minimizing volatility.  And while still a conservatively managed fund, our slightly more aggressively managed portfolio, the Strategas Go Anywhere Strategy, also seeks to maximize returns and minimize volatility without the tracking error constraint. 

For additional information on the above fixed income products, Strategas Asset Management, how to access our research or our other investment solutions please visit our website: https://www.strategasasset.com/ or reach out to Patrick Rista, prista@strategasasset.com / (646) 292-7984.

-Thomas Tzitzouris

This communication was pepared by Strategas Asset Management, LLC ("we" or "us" or “our”). This communication represents our views as of 06/08/2023, which are subject to change, and are presented for illustrative purposes only. The information contained herein has been obtained from sources we believe to be reliable, but no guarantee of accuracy can be made. This communication is provided for informational purposes only and should not be construed as an offer, recommendation, nor solicitation to buy or sell any specific security, strategy, or investment product. This communication does not constitute, nor should it be regarded as, investment research or a research report or securities recommendation and it does not provide information reasonably sufficient upon which to base an investment decision. This is not a complete analysis of every material fact regarding any company, industry, or security. Additional analysis would be required to make an investment decision. This communication is not based on the investment objectives, strategies, goals, financial circumstances, needs or risk tolerance of any particular client and is not presented as suitable to any other particular client. Past performance does not guarantee future results. All investments carry some level of risk, including loss of principal.

Strategas Asset Management, LLC is an SEC Registered Investment Adviser affiliated with Strategas Securities, LLC, a broker-dealer and FINRA member firm, and an SEC Registered Investment Adviser. Both Strategas Asset Management, LLC and Strategas Securities, LLC are affiliated with Robert W. Baird & Co. Incorporated ("Baird"), a broker-dealer and FINRA member firm, and an SEC Registered Investment Adviser, although the firms conduct separate and distinct businesses.