Displaying items by tag: fed

In recent weeks, fixed income drifted lower due to concerns about Fed Chair Jerome Powell’s upcoming Jackson Hole speech, where he was expected to strike a hawkish tone given the economy continuing to expand at a moderate pace and inflation remaining well above desired levels. 

Powell did lean hawkish in his remarks but not enough to fuel further selling in bonds. Notably, he warned that the FOMC was prepared ‘to raise rates further’. However, he did temper this with constructive comments on the economy’s resilience and inflation’s path lower. Equity markets experienced strength following the remarks as the speech was less hawkish than expected.

The ultimate takeaway is that the Fed is still hawkish, considers inflation too high, and further hikes are on the table if necessary, but it’s less hawkish than a few months ago. Additionally, it sees the resilience of the economy and progress on the inflation front as reason to remain patient in its current stance which delays the idea that rate cuts are going to happen anytime soon. 

Thus, it’s not surprising to see odds for a rate hike later this year edge lower in addition to the odds of a rate cut in the first half of 2023. So far, the ‘higher for longer’ camp continues to be correct which is leading to weakness on the long-end and creating attractive opportunities on the short-end. 

Finsum: Fed Chair Jerome Powell gave his much awaited speech at Jackson Hole. He struck a relatively hawkish tone which was broadly in line with expectations.

The first-half of the year was defined by stock market strength and bond market wobbliness. In the second-half of the year, we are seeing an inversion of sorts as the bond market has weakened, while the stock market has been giving back recent gains.

This is a natural consequence of the market consensus being upended as it’s clear that the Fed is not going to budge from its ultra-hawkish stance for at least the rest of the year, inflation is stickier than expected, and that the economy is resilient enough to continue evading a recession. Treasury yields are also responding with the 2-year note yield reaching 5%, and the 10-year yield breaking out above 4.2%. 

Previous instances of Treasuries reaching these levels have resulted in equity weakness as it portends greater stress for banks, housing, and other parts of the economy. However according to Yardeni Research, bond weakness is more driven by a widening federal deficit and a better than expected economy. Another factor is the ‘pricing out’ of pivot in Fed policy from the second-half of this year to later in 2024. 

The firm sees the market continuing to rise despite yields remaining elevated and believes the S&P 500 will make new highs next year. 

Finsum: US Treasury yields are rising and leading to a pullback in the stock market. Some of the factors are the resilience of inflation, a stronger than expected economy, and a wider than expected federal deficit.

US Treasury yields surged to their highest levels in 16 years following the release of minutes from the July FOMC meeting. The minutes made clear that the Fed continues to lean in a hawkish direction despite some signs that the economy is decelerating, softness in the labor market, and moderation in inflation. Essentially, it’s another sign that rates will remain ‘higher for longer’ and that any pivot in Fed policy is nowhere near. 

In the minutes, the Fed said that there were ‘significant upside risks to inflation, which could require further tightening of monetary policy’. Following the release, yields on the 10-year Treasury reached 4.3% which is the highest level since before the housing collapse and Great Recession in 2007. 

In addition to the Fed, there are other factors that are contributing to selling pressure in Treasuries such as foreign governments reducing their holdings and expectations of supply hitting the market in the coming months due to the federal government’s funding needs.

Already, equity markets started to wobble and give back some of the gains made in recent months. Previous breakout in yields have resulted in sharp sell-offs in equities, and there is a risk that it could reignite the crisis in regional banks.

Finsum: US Treasury yields shot up to their highest level in 16 years following hawkish minutes from the July FOMC meeting. Other factors are also contributing to Treasury weakness, and it’s worth watching if it will result in damage to parts of the economy.

UBS shared its outlook on fixed income and high yield credit in a strategy piece. Overall, the bank is moderately bullish on the asset class, especially at the short-end of the curve, but doesn’t believe returns will be as strong as the first-half of the year.

Overall, it attributes strength in the riskier parts of the fixed income universe to a stronger than expected US economy which has kept the default rate low. This has been sufficient to offset the headwind of the Fed’s ultra-hawkish monetary policy. 

The bank attributes the economy’s resilience to lingering effects of supportive fiscal and monetary policy and the strong labor market. It’s a different type of recovery than what we have seen in the past where financial assets inflated while the real economy struggled. 

However, UBS believes that the default rate should continue to tick higher so it recommends a neutral positioning. It also sees a correlation between equity market volatility and high-yield credit. While this was a tailwind in the first-half of the year, it believes that it should be a headwind for the remainder of the year given high valuations. 

Overall, it sees a more challenging environment for high-yield credit and recommends sticking to the short-end of the curve to minimize duration and default risk.

Finsum: In a strategy piece on high-yield credit, UBS digs into its strong performance in the first-half of the year, and why it expects a more challenging second-half. 

2023 was supposed to be the year of fixed income. 

Coming into the year, the consensus was that fixed income would rally as the economy plunged into a recession, forcing the Fed to terminate its rate hike cycle and even begin cutting before the year was over. The bond bulls got another catalyst following the regional bank crisis which many believed would impair credit markets and also force the Fed’s hand.

Yet, these prognostications have proven to be false. Instead, the US economy continues to grow and add jobs every month. In fact, there are more signs that the economy could be re-accelerating rather than contracting. As a result, the Fed continues to hike, and bonds have given up all their gains on the year. 

Despite consensus predictions proving wrong, most Wall Street analysts remain bullish on fixed income. They continue to believe that yields are at or near their ‘cycle highs’ and that a trifecta of factors like cooling inflation, mild economic growth, and geopolitical risks mean that investors should continue adding exposure especially given that equities are unattractive from a valuation perspective at the moment. 

Finsum: 2023 was supposed to be a big comeback for fixed income given expectations of a recession in the second-half of the year. Yet, this has proven not to be the case.