Olumide Owolabi, Portfolio Manager—Neuberger Berman

February 8, 2021

Historically, real yields have tended to decline as the debt-to-GDP ratio rises. This reflects the “show-me-the-money” attitude of bond markets: Indebted governments are assumed to turn a blind eye to inflation while crowding out the real engines of growth—until the GDP data prove otherwise.

We think real yields will start to rise when certainty around fiscal support and vaccine distribution is established, leading to a reopened economy and an actualization of above-trend growth. At that point, we believe nominal yields will adjust rapidly, rising to regain a higher level of real yield and finally reprice for the increased supply of Treasuries issued to fund the unprecedented stimulus.

The appetite of non-U.S. investors for U.S. Treasuries could be one constraint on how high yields could go.

When the Fed finally responds to the new inflation dynamic, we believe it will do so more aggressively than the market anticipates. Nonetheless, we do think the market is right not to expect this for another couple of years. This anchor on short-dated rates, combined with a lengthening of the weighted average maturity of Treasury debt during 2021, could make for a substantially steeper U.S. yield curve.

This steeper curve may offer non-U.S. investors a meaningfully higher term premium than they are likely to get from their own bond markets, with a relatively low cost for hedging out U.S. dollar exposure. Could these non-U.S. flows into U.S. Treasuries be enough to prevent a substantial rise in long-dated yields over the next 12 to 24 months?

While non-U.S. demand could compress the U.S. term premium, it does not fundamentally change the direction of travel for the economy, the Fed and, hence, our expectation of higher rates. As such, we favor inflation-protected securities and have an underweight view on duration exposures in our portfolios as we head deeper into 2021.