June 15 2022

The State of US Dollar Yield

Are we done with the sharp moves yet?

Rates are expected to go up, with another 150bps hike in store for the Fed, as far as we know currently. This means that yields went up, and fixed income assets repriced down in order to account for this change. US dollar yields range from 3.33% for 2-year US Treasuries (317bps increase yoy) to 13.74% for Asian corporate high yield (+671bps).

The sharp increase in yields over the past year is both an effect of higher base rates, but also higher credit spreads to reflect increased risk. The latter is especially visible in high yield bonds in the US and Asia. Indeed, for leveraged corporates with a high level of debt on their balance sheet relative to their income, higher rates have a magnified negative impact. Moody’s, a rating agency, expects that default rates for speculative-grade credits would remain below their long-term average of 4% going into 2023.

Yields are at their 10-year peak under the Fed action. This action is performed to deflate asset prices and tame hyperdrive consumption that fuels inflation. In the meantime, the Fed is also reducing the size of its balance sheet i.e. selling bonds. This bond-selling program, to the tune of $1.1TN/yr, adds to the natural supply pressure of US bonds emissions to finance deficits. Both combined, it is estimated at a $2.6TN yearly supply.

The question is who wants those Government bonds? Banks can probably absorb $500BN/yr top, and foreign Governments may have limited appetite in a rising rate environment. Mind you that the latter probably have to sell USD assets, and not buy, to maintain their currency afloat at present. All-in-all, there is an excess of $2.1TN supply of US treasuries that needs to find a home.

The bet is that households would mop this up. The good thing is that they can, as US bank deposits increased by ~$5TN since the latest covid-driven QE. But should they? The only palatable reason would be to identify a compelling risk-return to do so. With inflation and rates still on the rise, the bet into US treasuries is still risky. However, a 3.33% on a 2-year Government bond starts to become attractive for a relatively safe placeholder, while the risk assets are crashing.

At least this 3.33% now looks better than any unlevered USD yield strategy in DeFi at the moment. The Convex 3Pool yields 1.43%, while the higher contract risk FRAX+3Crv yields 4.18%. Overall, US dollar yielding products are in flux at the moment, and opportunities should get more interesting soon.

What’s next? It is pretty clear that leverage is being washed out of the system, and risk positions are relinquished one by one. Unless you’re short the market overall, very little positioning is paying out. It pays off to be patient with as much short-term liquidity as you can, and long-term debt lines ready to be drawn should you need it. Working on market-neutral positions may work in the interim, as high volumes would make it worth your while.

Hold tight, the bottom is near.

About –

360 Advisory LLC is a Boston-based RIA managing investments, including crypto