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Fixed Income Research, Georgia

Fixed Income Strategy Market Update

May 31, 2018
Intended for Institutional Investors Only – See Important Disclosures Below

RATES COMMENTARY: FED PAUSE

On May 2, 2018 the Federal Reserve took a pause in its rate hiking cycle. The benchmark ten-year treasury rate rose during the two weeks following the FOMC meeting  to a high of 3.115%, but has subsequently declined 2.822% at month end. We believe the rally was largely a result of the large spreads between German bunds and US bonds. The fed funds futures market anticipates that the Federal Reserve will once again raise rates, but at a slower rate with an implied rate of 1.822% rate for June and 2.10% by November and 2.41% by June 2019 before slowing still further to 2.60% in March of 2020 and 2.63% by December of 2021. We continue to view the fed funds rate as accommodative, but believe a move above 2% will proof restrictive over time. Current inflation measures are running well above 2% and have consistently registered above this threshold since the 2016 election, however, the 10-year realized inflation rate still clocks in at a paltry 1.5%. The Taylor Rule estimates argue that the neutral Fed Funds rate should be in the 4.90% region, however, we believe the low level of spreads suggests market participants anticipate that this tightening cycle should begin to bite at some point during 2019. In fact, 3 year rolling returns for most maturities are now below the 3 year rolling returns on T-Bills, which is a common feature towards the end of rate hiking cycles. From this point forward, we believe the risk to duration is lower than many market participants currently believe, particularly when viewed over the horizon of the security. Over long periods of time, the Federal Funds rate and inflation rates have generally tracked each other. This relationship, which had broken down during the Federal Reserve’s extended Q.E. policies has essentially normalized as of the end of February, and we believe will continue to normalize as the Fed chases shorter term inflation readings. The market is currently forecasting just an additional 40 bps of tightening this year, whereas just a month ago the Fed and market participants were discussing at least three additional hikes in 2018. We are increasingly concerned that the political nature of the Fed is leading to a third asset bubble in the stock market.

KEY RISKS:

Risk to our view include 1) higher than anticipated inflation 2) political risk 3) unexpected currency risk and 4) municipal credit risk.

 

IMPORTANT DISCLOSURES: This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. The views expressed in this report may differ from the views offered in FinTrust Brokerage Services, LLC debt research reports for retail investors. This report may not be independent of FinTrust Brokerage Services, LLC proprietary interests. FinTrust Brokerage Services may trade the securities covered in this report for its own account. Such trading interests may be contrary to the recommendation(s) offered in this report.

Please see page 7 for analyst certification and additional disclosures.

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