The market started the year off strong, but forecasts were derailed by the unusually cold weather and geo-political tensions.
By Steve Van Order, Fixed Income Strategist
The market started off the year with the conviction that the Fed would respond to expected stronger growth by starting the “lift-off” of policy target rates in the first half of 2015. Then, as happened every year since the crisis, things derailed forecasts. Economic growth stalled in the winter, GDP contracted, and geopolitical tension abounded. All of a sudden, Treasury yields looked attractive. Helping Treasuries along was their relative cheapness against other advanced economy government bond yields. The ten-year T-note hovered a tantalizing 120 bps over the average of the other three big markets (the Bund, JGB, and Gilt). Once the weak US data had run its course and a spring rebound of some sort seemed likely, instead of rising, Treasury yields were pulled yet lower as the Bund yield fell in expectation of ECB easing. Yee gads, that move was the coup de grâce. The bears in US Bondland were in a fix, and in May this capitulation provided a technical pulse lower in yields.
Where does this leave us at the start of June? For starters, Bund, JGB, and now Treasury yields are quite low. For these levels to be sustained, at a minimum, the ECB must not under-deliver in its policy decision this Thursday. In fact, even if the ECB delivers the minimum, then that outcome might trigger a correction in euro area havens and push global rates a bit higher. What global Bondland really wants from the ECB is a hint that a QE, or even intervention to weaken the euro1, is being more actively discussed. But we think it will be way too early for the ECB’s head, Mario Draghi, to comment on this in his post-meeting presser. Back in the US, the highlight will be the employment report for May, which remains the single-most market-moving data set we see.
As we move through the middle and into the later stages of the greatest global yield chase in our times, we are alert for signs of later stage behaviors. We have seen some evidence, primarily in expanded use of derivative-based yield enhanced vehicles and leverage. Collateralized Loan Obligation issuance is on a strong pace. In the ETF world, there is experimentation with various ways to boost yield via derivative exposure and leverage.
We believe that non-leveraged traditional products, such as high yield and US dollar emerging market government bonds still offer reasonable yield and spread for risk when needing to move along the yield spectrum. Credit spreads are likely to remain stable but tight. Blending these products into a diversified portfolio is the way to go. To those still in cash/liquidity, we suggest a move into the very-short duration categories, which can offer at least positive income with some downside protection.
1 This would require purchases of foreign government securities like Treasuries.
This commentary represents the opinions of the author as of May 30, 2014 and may change based on market and other conditions. These opinions are not intended to forecast future events, guarantee future results, or serve as investment advice. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither Calvert Investment Management, Inc. nor its information providers are responsible for any damages or losses arising from any use of this information. Calvert may have acted upon this research prior to or immediately following publication. In addition, accounts managed by Calvert Investment Management, Inc. may or may not invest in, and Calvert is not recommending any action on, any companies listed.