Bond Legend Dan Fuss on Rising Rates

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Having just celebrated his 80th birthday, Dan Fuss can claim a unique achievement – his tenure in the fixed income markets has spanned a full market cycle, from the great bear market that began in the early 1950s through the equally great bull market that commenced in 1981. Fuss said today’s environment most closely resembles what he confronted in the late 1950s, when long-term rates were 3% and beginning their march upwards.

Bond Legend Dan Fuss on Rising Rates

“Interest rates will go up a little bit,” he said. “We are in the foothills of a secular rise in interest rates.”

Fuss is vice chairman of Boston-based Loomis Sayles and manages the firm’s flagship Loomis Sayles Bond Fund. He spoke Thursday at the CFA Analyst Society’s fixed-income conference in Boston.

Fuss said the yield on the benchmark 10-year Treasury bond will increase to 4.25% “before this cycle ends,” but he did not provide a specific timetable for when that will be. He also said the steepness of the yield curve – between 10- and 30-year rates – will decline. Public-sector and defined-benefit funds are adopting a liability-matching strategy, which will cause them to purchase more long-dated bonds and push yields down on those bonds, he said.

In April of last year, Fuss predicted that rates would rise. But rates continued to fall until July of this year.

I’ll look at the assumptions behind Fuss’ forecast and his assessments across a range of sectors of the bond market.

The government’s need to borrow

Fuss based his interest forecast on an assessment of the government’s borrowing needs. Those needs, he said, are driven by four factors: peace, people, politics and prosperity.

Peace is the most important, according to Fuss, because it determines a very critical component of the budget – defense spending. Fuss said defense spending as a percentage of GDP has been “drifting down” and is now approximately 3.5%. The forecast, he said, is for it to drift lower.

That is a good sign for rates, he said, and it is a departure from previous trends over his long career. There are fewer than 800,000 active members of the military now, which represents a downsizing of our armed forces.

Two regions – the eastern Mediterranean and the South China Sea – are problematic, according to Fuss, and might require military intervention. Fuss said the administration’s so-called “pivot to Asia” has been delayed, and that region could benefit from more attention from our political leaders. But overall, he said the current level of defense spending was “very manageable” on a fiscal basis.

Fuss added a caveat, however. He said that if he is wrong and defense spending rises, then “all bets are off” with regard to interest rates and “we have a societal challenge in front of us.”

By “people,” Fuss was referring to employment in the U.S. He said the percent of the workforce currently employed is discouraging. But employment data are also difficult to interpret. Fuss said the definition of the size of the workforce is changing, as more young and old people are seeking jobs. Fuss said there could be “a whole lot more people in the workforce sending money to the Treasury,” which would reduce federal borrowing needs and keep downward pressure on rates.

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