Perhaps at odds with the Federal Reserve Board’s current guidance, U.S. credit markets have remained, in their own ways, extraordinarily calm in the face of approaching policy changes. In the first quarter, the story of the fixed income markets remained more one of “steady as she goes” than the doom and panic one might have expected. Nominal interest rates remain at historically low levels, and credit yield spreads have also adjusted little to any possible change in Fed policy. Even the shape of the U.S. Treasury yield curve, which had been steadily flattening for a couple of years, has a normal configuration. Despite steadily improving labor market conditions and optimistic economic sentiment readings, current bond pricing appears to be immune to the risks of a significant increase in interest rates. When will the great bear market in fixed income finally get started?
After seven years of extraordinary monetary policy directives, the Federal Open Market Committee (FOMC) has opened the door to the idea that economic conditions could justify the beginning of a return to normalcy in terms of nominal, especially short-term, interest rates. However, the Fed has not provided a firm timeline for re-establishing rates at levels more consistent with a healthier economic backdrop, and is instead expected to remain “data dependent” going forward. Investors certainly do not expect FOMC action soon, as evidenced by the yield on U.S. 10 year Treasuries, which has actually declined slightly since the beginning of the calendar year, from 2.17% to 1.95%.
After such a long period of monetary accommodation, we anticipate that employment gains and springtime expectations for growth in economic data releases could be the drivers for the Fed to push rates higher. However, such an interest rate outlook is moderated by 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 Fed. Their mandate is to foster both price stability and maximum employment. Clearly, the markets observe that the varied measures of price pressures show limited upside price momentum that would cause the FOMC to tighten policy rates.
If and when data on inflation and/or the strength of the economy shifts, we anticipate the FOMC may be forced to begin reversing years of monetary stimuli. But until then, the credit markets may well continue along the current path of low and stable interest rates. 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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