This article was released on May 1, 2018. Find our latest U.S. fixed income insights here.
Economic and market perspective
After being introduced in March, the tariffs remained a topic in early April. The spat between the United States and China appeared to escalate as each country announced new rounds of tariffs against the other, covering an increasing list of the other’s exports. The trade dispute appeared to be intensifying until a speech by Chinese President Xi Jinping at the Boao Forum for Asia, which was interpreted as striking a conciliatory tone, calmed nerves. Xi declared a “new phase of opening up”, including increasing imports, greater protections for intellectual property and looser rules around foreign ownership of manufacturing companies. President Trump praised the speech, lowering market concerns of a trade war.
After Syria again used chemical weapons against its civilian population, the U.S. stated its intention to launch missile strikes against the Assad regime. Russia threatened the U.S. against firing missiles, leading to increased tension in the region as the U.S. contemplated its options. Eventually, in a joint mission, the U.S., the U.K. and France fired missiles against Syrian government targets. Despite the threats, Russia did not retaliate, lowering tensions.
North Korea, which had caused several bouts of market volatility with nuclear missile tests and verbal sparring with President Trump, declared a moratorium on missile tests in April. The leaders of North Korea and South Korea had a public handshake, considered a significant breakthrough, and North Korea indicated a willingness to discuss denuclearization. For the time being, this reduces one source of geopolitical risk.
Minutes from the March 20-21 meeting of Federal Open Market Committee released in April were viewed as having a slightly more hawkish tone than prior minutes. At that meeting, as expected, the Fed delivered a 25 basis point hike, bringing the Fed Funds rate to a range of 1.5-1.75%. Noteworthy in the minutes, “all participants” saw an improving economy and increasing inflation near term. With recent hikes and expectations of future ones, several FOMC members suggested the Fed’s policy stance language should be changed from “accommodative” to “neutral” or “restraining” in future meetings. The market is not projecting a rate hike at the Fed’s May 1-2 meeting, but projecting approximately a 90% probability of a hike at the June meeting.
In April, the ten-year Treasury hit 3% for the first time since 2014. Yields only briefly exceeded this level before falling below it, though remaining close through month end. Perhaps more significantly, the six rate hikes in the current Fed rate hike cycle combined with a relatively more contained long-end have led to significant flattening of the yield curve. By several metrics (2s10s and 5s30s), the yield curve hit its flattest level since 2007.
Outlook and conclusions
In our view, the ten-year Treasury hitting a symbolic level of 3% is far from a cause for panic. Instead, rates are reflecting the healthy and improving wage, inflation and growth picture in the U.S. None of these have given a cause for concern to date, though inflation in particular bears monitoring. The flattening of the yield curve should be monitored as well given the historical implications of an inverted curve, though to date, the curve is reflecting the realities of six Fed rate hikes and only moderate growth and inflation. Overall, economic data and monetary policy, furthered by reduced fears of a trade war with China, remain supportive of fixed income investment, but in the context of an environment with increased market volatility. The opportunity set for investors has become more appealing with yields on broad fixed income having reset to approximately 3.3%, the highest level since 2010.