(New York)
There are a lot of good reasons to own Treasuries right now, and a lot of reason to be nervous about them. Let’s take a look. The biggest risks in the market at present are mostly about the budget deficit, which makes Treasuries look weak and inflation likely to jump (as it has historically during such spending). However, there are a lot of positives too. The big one is that the Fed looks ever more likely to adopt a permanently dovish stance as it may be changing its thinking about inflation. Additionally, economic weakness will be bullish for Treasuries, so coming to the end of the cycle is not catastrophic.
FINSUM: The best place to be on the yield curve is clearly at the short end—less rate risk and decent yields.
(Washington)
The market seems to have forgotten about 2013’s Taper Tantrum. The bond markets appear to feel like they are back in the driver’s seat, and seemingly no one expects the Fed to suddenly turn hawkish. A similar set up existed in 2013 prior to the big market meltdown referred to as the “Taper Tantrum”. The thing to bear in mind is that Fed chief Powell has made clear he doesn’t like being bossed around by the White House or the markets, so will not be afraid to be one step ahead of markets in making a sudden hawkish move. It is important to remember then that a survey of economists shows that they expect another rate hike this year.
FINSUM: The Fed is made up of economists, so that survey could have value. That said, we do lean towards the “no further hikes” in 2019 camp.
(New York)
Investors are anxious about the chances of a recession right now. While the Fed doesn’t seem likely to hike us into one any longer, economic fundamentals have just begun to show cracks. It started with housing, then job growth for February, and now it is jobless claims. Jobless claims rose by 6,000 last week after a long stretch of falling numbers. Weekly numbers are seen as less reliable than monthly figures because of random gyrations, but the data could indicate the economy is starting to soften.
FINSUM: It is too early to tell whether this is indicative of a coming softening or just an aberration, but certainly something to pay attention to.
(New York)
If you are of the opinion that rates are not going to move higher, or if just want some great yields and aren’t too worried about rates, take a look at mortgage REIT ETFs. Mortgage REITs are a special subsector of the REIT industry, and have recently become greatly more accessible because of ETFs. For instance, consider the iShares Mortgage Real Estate ETF (REM). The fund has a 30-day SEC yield of 9.36%. It is obviously rate sensitive, but even during last year’s brutal hiking cycle, it only lost 3.75%.
FINSUM: If the Fed stays put this year, which it likely will, these could be a great investment as we head into a downward rate cycle.
(New York)
Bond investors are getting nervous, and not about the Fed or interest rates. Rather, they are worried about corporate credit. Most will be aware that corporate credit issuance surged over the last decade, especially in fringe investment grade BBB debt. Now, investors are fearing a “wall of maturities”. In the next three years, one third of all triple B rated US debt will come due, a huge test for the group of highly indebted companies. Companies will then need to refinance in this much-less-friendly environment. The Bank for International Settlements warns that in the next downturn, many BBB rated bonds will be downgraded to junk, which will cause fire sales.
FINSUM: Our big worry here is that many institutional investors have strict mandates to not hold junk bonds, so if a solid number of companies fall from the BBB level, there will indeed be huge fire sales in credit markets.
(New York)
With all the newfound reticence of the Fed, one important fact remains—they could hike at any time. The Fed was hawkish for a long time, and as dovish as they have suddenly become, a position shift on rates could be quick. Accordingly, when considering income-focused investments, advisors need to be very mindful about rate risk. One way to earn good income while also hedging against rates is to look at short term bond funds. Zero and short duration bond funds have little to no rate/duration risk, which means they can earn income without the threat of big losses coming from movements in rates and yields. Some funds to consider are the ProShares Interest rate hedge family or the Fidelity Limited Term Bond (FJRLX), the latter of which yields 2.89% and has a duration of 2.4 years.
FINSUM: Short-term yields have come up so much that limited term bond funds now look like a great buy for stable income without so much capital risk.
(New York)
We have been tracking the economy closely looking for signs of the pending recession that everyone is so worried about. Labor market data last week set off a lot of red flags, and now things are on even more unsure footing. New data released shows that inflation rose at just 0.2% in February, representing an annual gain of 1.5% over the last twelve months. The low inflation means the Fed is not rushing, with Fed chief Powell commenting last week “With nothing in the outlook demanding an immediate policy response and particularly given muted inflation pressures, the [Federal Open Market] Committee has adopted a patient, wait-and-see approach to considering any alteration in the stance of policy”.
FINSUM: This just seems like a return to the post-Crisis norm that we have had. Maybe we will fall back into the several year mode where growth was 2% and inflation was 1.5%.
(Washington)
The whole market rally this year has pretty much been predicated on the Fed u-turning on rates. This makes sense, as it signaled that the Fed was not going to hike the economy into a recession. However, there are reasons to be nervous that the Fed may reverse course. One top economist thinks that the Fed may hike twice more this year as strong economic data will start to push Powell’s hand. US service industry data has been quite strong, and overall, “The fundamentals are not that bad. That could mean Powell has no choice but to hike.
FINSUM: We don’t necessarily agree with this view. While we are nervous about the Fed reversing course, we don’t think they will be under pressure to do so until inflation actually heats up.
(Washington)
Once you admit that this 2019 rally is almost purely predicated on the Fed dramatically turning around its position on rates and the economy late last year, you come to a realization: it could all end so quickly. The market is very vulnerable to the Fed’s actions right now, so the question becomes—will the central bank turn hawkish? The short answer is that it doesn’t look like the Fed will get hawkish any time soon. New language released in the latest notes look even more dovish than in December. The key buzzword is that the Fed is looking to be “patient” on rates and says it would need clear upward signs in the economy to hike any further.
FINSUM: The Fed has set up another goldilocks situation for markets. So long as data is okay but not too good, asset prices will be fine. If some data comes out poorly, the market knows the Fed can cut rates. Are we in for another big bull run?
(New York)
Stock investors may have largely moved on from day to day concerns about a pending recession, but important parts of the bond market are still signaling a downturn is coming. For instance, the 1 to 5-year spread in Treasuries inverted at then end of December, and despite the Fed making a big policy u-turn, has remained inverted ever since. The spread is currently minus 7 basis points. It is important to remember that the entire yield curve does not invert at once, it happens in stages, and this particular measure has proven to be a good recession indicator in the past.
FINSUM: It is alarming to us that this remains inverted despite the drastic change at the Fed. From here forward we expect the curve to be very data dependent, as if economic data is worsening, we expect more and more of it to invert.
More...
(Washington)
Several weeks ago the Fed slammed the brakes on more rates rises. The market has taken a deep sigh of relief to the tune of major gains in stock indexes. But within the pause is a more sophisticated, and perhaps more consequential, rethink of the Fed’s goals. The Fed is puzzled by weakness in inflation. With the labor market so tight, inflation should be rising strongly. Yet it has failed to reach the Fed’s two percent goal and appears to be weakening again. Accordingly, there are discussions going on internally at the Fed, about the disconnect and how to approach it.
FINSUM: There is a major question here—will the Fed revise its target higher and take a more aggressive approach to boosting the economy, or will it leave the target at 2% and be content. In either scenario, rates look unlikely to rise soon.
(New York)
The yield curve narrowed continuously throughout most of 2018. The spread between 2- and 10-year Treasuries fell to just over 9 basis points in December and sits at 14 now. Where is it headed? The answer is likely towards an inversion. The Fed is releasing its minutes, and once it does, it seems likely the spread will continue to narrow. There are two scenarios that would likely create an inversion. The first is if the Fed minutes show that the central bank may raise rates again soon (sending short term yields higher). The other, and perhaps more likely, scenario is that the Fed expresses some anxiety about a recession (pushing long-term yields lower).
FINSUM: This is interesting because the two most likely scenarios for what the Fed might say/do in the near-term both add up to the same thing—a yield curve inversion.
(Miami)
FINSUM is at the Inside ETFs conference in Hollywood, FL this week, and we wanted to bring you a little live coverage. Yesterday, there was a major session at the event discussing the outlook for fixed income. The consensus was that even though the Fed has paused, there is now way to tell when rates may rise again. Further, while China’s economy looks weak right now, that could turn around rapidly in the event of a trade deal with the US. Finally, all of the five panelists discussing fixed income said the ”liquidity mismatch” between ETFs and fixed income instruments is overblown and that there is not nearly as much to worry about as some think.
FINSUM: Fixed income’s outlook is murky right now. On the one hand, the Fed has paused, but on the other, rates could start rising anytime. On balance, we do think the risk-reward is slightly in favor of a shorter-duration long position.
(New York)
Some advisors are always searching for the next blow up on the horizon. Well, with that in mind, Fitch has just put out a warning to investors that the next big market storm will likely start in credit funds. Fitch’s warning is predicated on the well-trod idea of a liquidity mismatch between the daily liquidity that open-end bond funds offer, and the relative illiquidity of their underlying holdings. In December, open-ended loan funds saw steep withdrawals, which led to big losses.
FINSUM: This is a fairly well-covered topic, but it is still a big risk. It has not yet happened on a major scale, but if it did, the potential for losses is massive.