The U.S. credit markets meandered through the second quarter of this year searching for guidance and a sustainable direction. In the end there was little of either. Economic data was mixed, surprising, and contradictory. There were explanations, theories, and corrections. The overall environment seemed healthy, growth appeared to be intact, but were conditions robust enough to warrant higher Federal Reserve Board short-term interest rate targets? It was beginning to look like the answer was yes, and official remarks from Board members pointed to the second half of 2015 as the likely start of the first interest rate hikes since the banking calamity of 2007-2008. The market took note and began to re-price the U.S. Treasury yield curve to reflect the expected Federal Reserve movement. The 10-year Treasury yield rose about 0.40% to a high over the quarter of 2.48%. Investors wondered, was a 3.00% 10-year in sight? Well, not quite yet: economic data points softened and conditions across major international trading partners appeared to be worsening, most notably in China and Europe, where once again Greek debt problems cast doubt on the long-term foundations of the Eurozone.
The relative appeal of U.S. dollar investments steadied the U.S. Treasury market. More importantly, the Federal Reserve’s guidance was delivered with an indication that the path to higher rates, while still potentially beginning in 2015, would likely be slow and perhaps more deliberate than had been anticipated by investors. Significantly higher rates were no longer as imminent. More data was required before a rate increase became a matter of fact. And so the market continued, back and forth between credit bulls and bears. In the end, the quarter was a minor disappointment for bondholders on a total rate of return basis. Most indices posted slightly negative returns, but year to date performances remained slightly positive overall.
With geopolitical unrest, global disinflationary forces, and aggressive monetary easing policies in other parts of the world, the lack of inflationary forces in the domestic economy is certainly not lost on the Federal Reserve. Yet after such a long period of monetary accommodation, we anticipate that employment gains and expectations for growth in economic data releases could be the drivers needed for the Fed to ultimately begin to push rates higher.
That said, the Fed has indicated that the pace of any rate increases would be gradual, and that monetary policy would likely remain relatively accommodative for quite some time. In the meantime, income, even of an anemic variety, is earned on fixed income investments every day, and waiting on the sidelines for the perfect entry point may quickly become too expensive to endure.
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