In May, a new record was set for monthly issuance of investment grade corporate bonds with approximately $170 billion brought to market. This total is notable given the weak demand and low issuance earlier in the year. Support has been strong for issuance between a healthy domestic appetite, international investors eschewing negative rates globally in favor of USD denominated securities and the European Central Bank (ECB) beginning direct purchases of corporate debt in June.
The next ECB meeting is set for June 2 with consensus expectations of no change in policy. European CPI remained negative, with a -0.1% preliminary CPI year over year in May and core CPI rising modestly to 0.8% for the trailing twelve months from 0.7% in April. Inflation has remained below the ECB’s 2% target since mid-2013.
The United Kingdom European Union membership referendum, or “Brexit” vote, occurs on June 23. Recent aggregates of polls suggest that ‘stay’ is leading ‘leave’ by a few percentage points; however, a large number of voters remain undecided. Details of the mechanism of departure, and thus the implications of such a vote, are not fully known, but a ‘leave’ vote would raise some of the same questions regarding the European Union that were contemplated as Greece teetered on the edge of default and potential exit in years past. Hoping to avoid another round of questions about Greek solvency as loans come due in July, the International Monetary Fund (IMF) and EU agreed to another package of aid to Greece in exchange for additional austerity measures.
Continuing a pattern of recent stabilization and more positive data, Chinese Manufacturing Purchasing Managers’ Index (PMI) data remained unchanged in May with a reading of 50.1, above 50, the level which indicates expansion.
Minutes of the April 26-27 FOMC meeting were released in mid-May and altered market perceptions regarding the timeline for the next rate hike. The minutes noted that “it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June” given a set of economic criteria continuing their improvement. In a subsequent speech at Harvard on May 27th, Chair Yellen said that the Fed should “gradually and cautiously increase our overnight interest rate over time, and probably in the coming months such a move would be appropriate.” Based on the minutes and Yellen’s comments, Fed Funds futures at month end have risen to projecting approximately a 25% likelihood of a June rate hike. For July, the futures project a 60% chance for one or more hikes.
Housing data has continued to improve in the U.S. New home purchases rose to their highest levels in eight years and Pending Home Sales Index reached its highest level in over ten years. The S&P/Case-Shiller Home Price 20 City Composite Home Price Index reflected continued home price appreciation with the index rising 5.4% over the trailing twelve months as of March.
In our view, May represented a veritable sea of calm following rate and spread volatility earlier in the year. With Fed expectations being the most significant change in the past month, our views on the attractiveness of high quality U.S. fixed income in a global context remain intact. The more hawkish Fed minutes paired with moderately strengthening U.S. economic data and stabilizing commodity prices have led to increasing expectations around a near term rate hike from the Fed. Signs of wage growth and U.S. inflation in the range of the Fed’s target are balanced off by more concerning elements including continued weak inflation abroad and the potential for disruptive geopolitical events – notably the Brexit vote. The Fed is considering this balance as they plan the second step of a multi-step normalization process. We view the timing of the next move as unlikely to alter the slow and methodical path of hikes looking forward and we continue to view the Fed as broadly accommodative.
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