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For U.S. equity investors, the last few months of trading action have been directionless, maybe even boring. Since early February, the S&P 500 has vacillated in a narrow band of less than 100 points, or about 4%. Although there have been some big moves on certain days, for the year, the broad stock market index has generated a total return of only 2.7% (as of June 12).

In contrast, the main action has been in the normally staid fixed income markets. After falling to a yield of 5 basis points in mid-April, the 10-year German bund yield soared to over 1% last week before rallying at week’s end. For the unfortunate investor who bought bunds at the low in yields, their bonds are now worth about 9% less.

The sharp sell-off in German bunds (and other European sovereign bonds) was due primarily to two factors: 1) a reversal of the widely-held view by professional investors that the European Central Bank’s large-scale bond purchasing would continue to drive yields even lower, and 2) evidence that European inflation pressures were mounting, which alleviated fears of a destructive deflationary spiral.

In the U.S., the bellwether 10-year Treasury note yield followed suit, rising from a low of 1.87% in mid-April to almost 2.5% by early June. Some of this move could be attributed to better economic news recently, but most of the backup in yields occurred during a period of weak economic data in the U.S. For bond investors, these are big moves.

Some industry experts are citing the lack of liquidity in the fixed income markets as a reason for the heightened volatility. New banking regulations both here and in Europe have forced many large investment banks to curtail their market-making activities in the bond market, and shrink the amount of fixed income inventory they are holding on their balance sheet. In the absence of a highly liquid, smoothly functioning bond market, some are concerned that large-scale redemptions (brought on by higher interest rates, for example) could result in heightened volatility and large losses for bondholders.

At City National Rochdale, we share the industry’s concern about the impact of the lack of liquidity in the bond market. However, we believe it is important to distinguish between mark-to-market volatility and permanent impairment of capital. While our clients would be subject to the same downward pressure on their bond holdings in a panic-driven sell-off , it is likely to create significant opportunities for patient investors that can ride out the volatility. Investors in ETFs and open-ended mutual funds (outside of those managed by City National Rochdale) may not have this luxury: they are vulnerable to other shareholders electing to sell, and forcing managers to liquidate bonds in a declining market.

For those that can distinguish between opportunity and true crisis, significant future upheaval in the bond market could be quite rewarding.

Investment and Insurance Products: 
• Are Not insured by the FDIC or any other federal government agency 
• Are Not deposits of or guaranteed by a Bank or any Bank Affiliate 
• May Lose Value

 

Important Disclosures

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed.

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as on the date of this document and are subject to change.

All investing is subject to risk, including the possible loss of the money you invest. When interest rates rise, bond prices fall. 

This material is available to advisory and sub-advised clients of City National Rochdale, LLC, a Registered Investment Advisor and a wholly owned subsidiary of City National Bank.