(New York)
The general understanding of markets is that bond investors are signaling that there is going to be a recession. Treasury yields have tumbled, and the Treasury yield curve has inverted, both signs of a coming downturn. However, the corporate bond market is sending a different signal, and it is worth paying attention to. The big sign of economic worry in the corporate bond markets is widening spreads between investment grade bonds and junk, but that is exactly the opposite of what is happening. The market is sanguine, and showing little of the concern that Treasury markets are. “Corporate spreads are extraordinarily narrow”, says Dan Fuss, vice chairman of Loomis Sayles.
FINSUM: This is a very good sign in our opinion. While it could turn out to be wrong, we do think this signals that Treasury investors may simply be overreacting.
(New York)
For the last year all the fear in bond markets was about inflation and how the Fed would handle it. Were we going to be hiked into a recession? Now all of that has shifted and fixed income gurus are concerned over an entirely different beast—recession. In many ways the fears of recession have become so strong that they are intimidating the market as a whole, making the term “bond vigilante” more than appropriate here.
FINSUM: The speed with which the bond market has reversed since December is pretty alarming. We do wonder if this inversion might be a false signal.
(New York)
The professor who first identified yield curve inversions has written an article explaining what the development really means. First identified in 1986, a yield curve inversion is considered the most widely accurate indicator of recession. Since it was first identified and back tested, it has accurately predicted a further 3 out of 3 recessions. This is a point its “discoverer” Campbell Harvey hammers home in his article. He explains that an inversion is usually followed by a recession within 12-18 months. The yield curve has not been inverted since before the Crisis, but just did so on Friday.
FINSUM: One of the important points Harvey makes is that in order for the inversion to really indicate a recession, it needs to remain in place for at least three months. We are only at one day.
(New York)
It finally happened. After dangling on the edge of an inversion for months, the US yield curve has just officially crossed into one. The gap between 3-month and 10-year Treasury yields is now negative. 10-year yields have been falling, recently hitting a low of 2.439%. Yield curve inversions are seen as the most reliable indicator of forthcoming recessions. Yields have been falling as a reaction to a highly dovish Fed and weakening economic data.
FINSUM: This is a reason to worry about he economy, but remember that there is often a long lag between an inversion and a peak in the stock market.
(Frankfurt)
In another sign of the deteriorating global economy, bond yields in Europe are once again moving negative. German Bund yields fell in trading recently and are now below zero. The move reflects the recently weak data coming out of Europe as fears grow about a recession there. Europe had seen negative bond yields for a long period until the brief bout of economic strength over the last couple of years.
FINSUM: Can the US be the odd man out in deflecting the global downturn? We have done it before, but this time feels different.
(Washington)
The bond market seems to have blind faith in the Fed right now. Longer-term bond yields have fallen dramatically, a sign that fixed income investors are sure the Fed is not planning any moves. Not only are bonds up considerably lately, but implied volatility is very low. That means investors are discounting both the chance for an inflation increase and an economic downturn. In other words, they think the economy and Fed is going to stay right where it is.
FINSUM: Can you blame them? The economy lingered in what we think of as an investor’s “goldilocks” phase for several years after the Crisis—inflation not too low, not too high, Fed on hold, asset prices rising. It does not seem unlikely we go back into that mode.
(New York)
Right now might not seem like the most important time to buy rate-hedged or short duration funds. The Fed is supposed to be on “pause” after all. However, in our view, now might be a critical time to have some rate hedged assets in the portfolio. The reason why is that yields have pulled back strongly from just a couple of months ago, including yesterday, but given the fact that it is almost purely the Fed which has caused the sharp reversal, rates could swing just as wildly higher if their comments, or economic data, changes. In other words, the bond market looks overbought right now because of Fed comments, but it could easily snap back to where it was in December in violent fashion.
FINSUM: We think this is a time for caution on rates and yields given how strongly the market has reversed over the last couple of months.
(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.
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(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%.