Asset Management: Fixed Income Insights

December 2017 Fixed Income Market Update

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Economic and market perspective

On November 16th, the U.S. House of Representatives passed tax reform long anticipated by the market. On November 28th, the Senate Budget Committee approved bringing the bill to the broader Senate. Various tweaks to the bill have been debated among Senate Republicans as the bill has been expected to only garner Republican support. The bill appeared to be losing momentum, but is now expected to come to vote on December 1. The House and Senate versions of the bill include differences that will have to be addressed in the reconciliation process. Among the expected differences, the Senate version includes the repeal of the individual mandate within Obamacare.

North Korea launched another missile test during November, saying that the Hwasong-15 missile could be armed with a “super-large heavy nuclear warhead.” In this test, the intercontinental ballistic missile rose to the highest altitudes yet seen from North Korean missile tests before landing in Japan’s exclusive economic zone. It is believed that if fired on a more standard trajectory this missile would have enough range to threaten any part of the United States. The move is seen as the latest provocation from the rogue nation to regional and global stability. After speaking with Chinese President Xi Jinping, President Trump called for “additional major sanctions” on North Korea.

On November 2, President Trump announced his nominee for the next Chair of the Federal Reserve to be Jerome Powell, a Fed Governor since 2012. On the Dovish/Hawkish scale, the presumptive Chair is viewed as having a generally similar dovish outlook to Chair Yellen. Mr. Powell’s confirmation hearing before the Senate Banking Committee began on November 28th, he is expected to be confirmed. Chair Yellen announced that she would resign her Fed Governorship after her successor takes office. During November, President Trump nominated Marvin Goodfriend, an academic with Fed experience, for one of the open governorships. Assuming he is confirmed, two additional seats remain vacant with another opening with resignation of Yellen in February.

As expected, the Federal Open Market Committee did not raise the Fed Funds rate when it met on October 31-November 1. The minutes from that meeting, released on November 22, reflect a generally positive economic outlook from the Fed, though noting that core inflation continues “to surprise on the downside.” The minutes indicate that the Fed expects to raise the Fed Funds rate in the “near term”, which the market has interpreted as the December 12-13 meeting. As of the end of November, markets are pricing in a near certainty of a hike at the final meeting of the year. Fed projections call for three additional rate hikes in 2018.

In her final appearance before the Joint Economic Committee of Congress, Chair Yellen emphasized the need to continue raising the Fed Funds Rate gradually to avoid causing “a boom-bust condition in the economy.” Her comments were interpreted as further supporting a December rate hike. She also observed that while asset valuations were “high by historical standards, overall vulnerabilities in the financial sector appear moderate” and that she was “very worried about the sustainability of the U.S. debt trajectory.”

Outlook and conclusions

In our view, the Fed has adequately signaled their intention to raise the Fed Funds rate in December such that the market will be comfortable when it is formally announced. Continued strengthening of the growth and employment data support such a move, while the calls for gradualism given the persistently below target inflation are also appropriate. With rates and spreads having moved little in the past month, but economic data continuing to improve on the margin and fiscal policy appearing more likely to support future growth, our outlook remains positive for fixed income overall with a focus on uncovering idiosyncratic security selection opportunities.

 

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