Top Weekly Themes
- FOMC meeting – glass still half empty – Last Wednesday, the Federal Open Market Committee (FOMC) completed its second meeting of the year. Consistent with prior meetings, the overall tone was dovish. Heading into the meeting, there were a couple of key items we were interested in learning more about: The updated Summary of Economic Projections and the Federal Reserve’s (Fed) views on the recent rise in long-term rates. Regarding the former, although economic growth, unemployment, and inflation are projected to improve, it wasn’t enough to alter the median forecast of a nearly 0.00% federal funds rate through 2023. And although the Fed acknowledged the quick increase in bond yields in recent months, they made it clear that the ongoing $120 billion monthly purchases is the right amount of accommodation given today’s economic environment. Problems would arise if higher rates prohibit economic growth or lead to tightening financial market conditions – neither of which is an immediate concern. The dovish tone contributed to a further steepening of the yield curve, with the spread between 2- and 10-year treasury bonds reaching the widest level since 2015. We continue to position portfolios for a steeper yield curve, believing that the Fed will be very patient before removing accommodative policy targeted at the short-end of the curve while having more tolerance for long-term rates to modestly rise coinciding with projected economic growth.
- Lackluster consumer spending likely to improve – Consumer spending unexpectedly declined 3.0% in February, partly because of abnormal weather conditions hitting certain parts of the U.S. Interestingly, the monthly decline marks the fourth time within the past five months that retail sales have been negative. We believe better days are ahead and anticipate consumer spending will be a major contributor to U.S. economic growth this year. Higher income levels, pent-up consumer demand, an expected reopening of the U.S. economy, and the recently-approved fiscal stimulus package will support consumer activity. President Biden signed the $1.9 trillion American Rescue Plan (ARP) earlier this month, which provides twice as much direct support to the consumer relative to the roughly $900 billion December fiscal package. According to the U.S. Treasury Department, $242 billion in stimulus checks have already been distributed. In January, the month following the prior fiscal stimulus bill, retail sales increased 7.6%. If January is any indication of consumer spending behavior, retail sales will likely bounce back in the months ahead.
- The American Rescue Plan (ARP) is municipal bond friendly – Issuer fundamentals in the municipal bond market are positioned to benefit from fiscal stimulus. The ARP will appropriate funds to different municipal sectors across the U.S., including the transportation, education, and hospital/healthcare sectors. State and local issuers are expecting to receive the largest allotment of roughly $350 billion. It was about a year ago (March 20, 2020), when high-quality 5-year AAA municipal yields jumped more than 200 basis points within two weeks, as investors were digesting COVID-19 related headlines. As we now know, investors’ worst fears of broad-based credit deterioration across the municipal spectrum never occurred. Instead, although pockets of credit stress certainly exist, there has been very strong investor demand in the municipal bond market this year. The recent signing of ARP is expected to continue to aid municipal fundamentals, a credit positive. Although valuations within the highest quality issuers have likely priced in the additional support, we believe there remains an opportunity within the high-yield tax-free market that stands to benefit from more directed aid. Recently, we modestly increased our exposure to this sector. Improving fundamentals, expected economic growth, and forthcoming fiscal aid is a good combination that should provide additional relief to weaker municipal credits.
|Equities||Week (%)||YTD (%)||1-Year (%)||3-Year (%)||5-Year (%)||Div Yield (%)|
|Russell 1000 Value||0.3||10.9||67.9||9.69||11.65||1.97|
|Russell 1000 Growth||(1.8)||(1.3)||73.7||19.92||20.80||0.73|
|MSCI EM (Emerging Markets)||(0.7)||4.7||75.4||6.45||13.28||1.82*|
|Fixed Income||Week||YTD||1-Year||3-Year||5-Year||Div Yield|
|Bloomberg Barclays US Aggregate||(0.8)||(3.7)||3.9||4.74||3.16||1.62|
|Bloomberg Barclays US High Yield – Corporate||(0.7)||(0.0)||26.6||6.44||7.79||4.57|
|Bloomberg Barclays Municipal Bond||(0.6)||(0.8)||7.3||4.86||3.51||1.25|
|Bloomberg Barclays Global Aggregate x US (Country)||(0.7)||(4.1)||10.8||2.12||2.62||0.93|
|Crude Oil WTI (NYM $/bbl) Continuous||(9.0)||23.8||194.8||(1.2)||7.9||60.1|
|Natural Gas (NYM $/mmbtu) Continuous||(7.1)||(0.6)||56.5||(2.2)||5.7||2.5|
|Gold NYMEX Near Term ($/ozt)||0.6||(8.5)||17.3||9.7||6.7||1,732.2|
|Copper Cash Official LME ($/mt)||0.3||17.4||87.0||9.5||12.2||9,090.0|
|Currencies||1 Week Ago||YTD||1-Year Ago||3-Years Ago||5-Years Ago||Current Level|
|U.S. Dollar per Euro||1.20||1.22||1.08||1.23||1.13||1.19|
|Japanese Yen per U.S. Dollar||108.49||103.25||108.49||106.10||111.40||108.98|
|U.S. Dollar per British Pounds||1.40||1.37||1.18||1.39||1.45||1.39|
Chart of the Week:
- U.S. Treasury yields have increased across the yield curve in 2021, with longer-term yields outpacing shorter-term yields leading to a steeper yield curve. Heading into this year, we anticipated higher long-term yields given our expectation of fiscal stimulus, vaccine distribution, and a reopening of the U.S. economy. Higher inflation expectations and an improving growth outlook would contribute to higher long-term yields.
- Short-term maturities are more sensitive to monetary policy. We believe short-term rates should be well anchored to Fed projections of the federal reserve target rate, which were updated at the March 17 FOMC meeting.
- According to the projections, the federal reserve target rate will remain near zero through 2023. Interestingly, the market is in complete disagreement.
- The Market Implied Policy Rate Chart indicates investors’ expectations of changes to the Fed’s main policy rate over the next three years. The blue line indicates that investors are currently expecting a rate hike within the next two years and three rate hikes over the next three years. The yellow line captures investors’ views three months prior, which were more in line with the Fed’s current projections.
- We believe the market continues to price in a much more aggressive Fed, which has contributed to the three-year U.S. Treasury yield more than doubling this year. In our opinion, the market’s disconnect to Fed projections has contributed to higher yields and opportunities in the belly of the curve. So as long as the Fed continues to reiterate its tolerance of higher inflation and discomfort for high U.S. unemployment, in our view, policy rates will remain very accommodative.
Widening investment grade credit spreads not overly concerning
Investment-grade credit spreads increased 10 basis points (0.10%) to begin the month of March, around the same time President Biden signed the USD 1.9 trillion American Rescue Plan.
At BMT, we are monitoring the direction in spreads, but are not overly concerned by the recent move. Rising credit spreads, because of tightening financial conditions, can certainly be problematic for economic growth; however, we don’t believe this is the case. It’s important to note that investment-grade credit spreads started 2021 within about 20 basis points of their tightest levels over the past 20 years. This provided little opportunity for notable spread compression. And yes, the recent jump in U.S. Treasury yields will contribute to higher corporate borrowing costs, but not at alarming levels. In fact, investment-grade corporate issuance in February hit a record high for the month as companies tapped the funding markets to take advantage of still historically low borrowing costs. Given the increase in supply, we believe a modest and likely temporary widening of credit spreads is logical.
We continue to believe an overweight to investment-grade corporate bonds is appropriate, given our outlook for positive economic growth. We aren’t expecting credit spreads to materially tighten further given current valuations. But we also believe any material widening will be met with increasing investor demand, given improving corporate fundamentals and the relative yield advantage versus government bonds.