Matterhorn, Switzerland

Fool Me Once, Shame On You. Fool Me Twice, Shame on 3… (percent)

3 minute read

The market is paying close attention to a critical 3% level for U.S. 10-Year Treasury bonds, which has implications for both domestic and international securities. Excluding utilities, sectors traditionally seen as stable sources of yield have recently underperformed, including consumer staples, REITS, and telecom.

S&P 500 QTD Return

Source: Bloomberg/R Squared Capital Management

It seems 3% is a key psychological level above which yields are expected to continue rising. However, we should remember that the 10-Year flirted with 3% in 2013, subsequently coming back down over the next four years (see the chart below); we can't automatically assume that yields will continue rising from here.

US 10Y Treasury Yields

Source: Bloomberg/R Squared Capital Management

So, what's the difference between 2013 and today? It is the U.S. budget deficit, both the absolute level and the growth trend. First, imagine if the U.S. had a budget deficit of $1 trillion. Sounds crazy, but it has happened before, and the Congressional Budget Office (CBO) expects to see this as soon as 2020 (according to its 10-year outlook). The deficit is about $600b now, but recent tax cuts and higher spending by the current administration are expected to push that number to $800b in the current fiscal year. As a result, the country's debt-to-GDP ratio is expected to reach 100% in ten years, a level not reached since World War II.

US Federal Debt as % of GDP

Source: Bloomberg/R Squared Capital Management

How did we get out of it last time? The entire world experienced post-war economic expansion for decades, most likely driven by high productivity growth (helped by automation), infrastructure spending, military spending, low rates, wealth distribution, progressive tax rates, low oil prices, and international cooperation. We will leave it to the reader to determine if today's parameters match those of the post-war era. Regardless, the way to alleviate debt levels is to grow the economy; yet, the CBO projects real GDP growth of a paltry 1.9%. This compares to the 4.0% growth seen during the post-war expansion until 1973, so we aren't optimistic about the U.S.'s ability to grow out of its piling debt burden.

The conclusion here is that the current strength in yields seems to have more support given the administration's approach to spending and taxes, and the lack of clear growth catalysts compared to historical analogs. The combination of elevated yields and an economic growth cycle in the late innings could cause investors to reprice risk. Only time will tell.

 Interested in having our insights delivered directly to your inbox? 

Subscribe to RSQ Blog

As international equity investors, the team at R Squared Capital Management (former team at Julius Baer / Artio Global) utilizes fundamental and macro analysis in our quest to correctly identify structural tailwinds and headwinds at the geographic, sector and company levels.   


Daeil Cha is a Partner and Analyst at R Squared Capital Management. 

Prior to joining R Squared, Daeil was an Analyst at Suffolk Capital Management.

Daeil received an MBA from Columbia University and a Bachelor of Arts in Psychology, with a focus on Neuroscience, from Princeton University.

To view other RSQ team member bios, click here.  

Posted by Daeil Cha on May 10, 2018 10:42:56 AM

Topics: International Equity, From the Desk of Daeil Cha


Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities, please see the R Squared Terms of Use page for a full disclaimer. 

Comments Welcome