Thoughts from our Domestic Fixed Income Team
A funny thing happened on the expected pathway through the first half of 2014 to higher US interest rates: the market took a detour. The consensus views at the beginning of the year were that economic growth and job creation would accelerate, the Federal Reserve would continue tapering its policy of buying Treasury and mortgage-backed issues to a full halt, and inflationary pricing pressures would build to the 2% target. All, supposedly, were going to combine and set the stage for the first short-term interest rate target rises since the 2007-2008 recession. From zero to perhaps 1% sometime in the middle of next year overnight rates were to rise…and who knew how much higher from there. Eeck! The yield curve would have to steepen in this scenario, and the longer maturity bonds undoubtedly would suffer the deepest price declines.
Under the sway of these primary assumptions, fixed income portfolio managers massively positioned issues as conservatively as their mandates allowed. In response to this ground swell of opinion, precautions had to be taken. Defenses were designed and dutifully constructed; interest rate hedges were set. All one had to do was wait for the pieces to fall conveniently in place, or so the story went, and then reinvest at higher nominal rate levels. Except a funny thing happened: it simply hasn’t worked out that way at all. In fact, US interest rates are lower, rather than higher, than they were last December. A long, bitter winter depressed economic growth, job creation was uneven, and inflation remained unthreatening. The Federal Reserve’s monetary policy guidance was extended to an indeterminable date, and while tapering of bond purchases remains on track, there’s been no shortage of other investors to purchase (and hold) the Treasury’s steady bond and note offerings. In response, hedges had to be lifted, portfolios were quickly re-designed, and probably most importantly, leveraged bets counting on rising rates had to be unwound as the pain of being incorrect grew too costly. There was more demand to cover short positions and prices in turn rose.
Today, concerns over unimpressive Chinese growth trends, geopolitical stresses in Ukraine, and newly-announced European Union policy changes to combat a disinflationary, low-growth quagmire on the continent have put further pressure on US interest rates from both fundamental and monetary perspectives to potentially fall from even today’s levels. Oh-oh, the credit market has moaned: perhaps our timing was off. Rates may be range bound for quite some time ahead.
Our point? Short-term interest rate forecasting has always been a difficult task at best which is better left to speculators (or extremely deep pockets). Similarly, picking the bottom of any market is wrought with unknowable dangers and disappointments. We therefore prefer to focus on the investment opportunities we can actually identify and quantify. And most importantly, we find investing considerably more productive when remaining disciplined, maximizing temporary dislocations to our advantage, and avoiding chases to the latest, red hot news stories. We remain cautious about inevitable rate changes, and have structured our portfolios accordingly, but we are fully invested despite the day-to-day commotion.
Submitted by: Howard S. Potter, Senior Fixed Income Portfolio Manager
This information is intended solely to report on investment strategies and opportunities identified by Roosevelt. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. References to specific securities and their issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Please contact us at 646-452-6700 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions, or if you would like to request a copy of our Code of Ethics. Our current disclosure statement is set forth on our Form ADV Part II, available for your review upon request, and on our website, www.rooseveltinvestments.com.