Risk Off, For Now

Mid Week Bond Update

Risk Off, For Now

If markets were seeking reasons to worry, they didn’t have far to look...


Adding to the mix: yet more sound and fury from the White House, as a long-standing belief in tariffs resurfaced and increased worldwide fears of trade wars.

Elsewhere, Italy’s elections revealed a tilt toward Euroscepticism without producing a governing coalition for now, and Germany finally produced a governing coalition, but the agreements that produced it may limit Chancellor Merkel’s maneuvering room. There was also mix of concern and relief in Asia after China’s leadership removed its term limits and the Koreas moved in the direction of reconciliation.
 

On the Rise: Fed Rate Hike Expectations

The Fed Funds futures market provides a useful, if volatile, probability path for Fed rate hikes. That path  just added one hike to its list for 2018, bringing the count to four – one for each of its major quarterly meetings, the first of which ends with a press conference and economic forecast on March 21.

 

Source: Bloomberg and Legg Mason, March 7, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


This week’s market unease will do more to pit the proponents of rapid growth against the worries of a surge of inflation. But the addition of the prospect of a tariff-driven end to synchronized global growth will  add another dimension to the worry, as might the Fed’s new chairman facing an ongoing test of the central bank’s independence.

For more on the prospects of inflation – or the lack thereof – read Western Asset’s Mike Bazdarich on why low inflation is no mystery.

On the slide: High Yield Spreads

As growth kicks in, the prospects for business failure wanes – at least in aggregate. That’s one reason the optimism about growth in the U.S., partially driven by the 2016 election, has driven high-yield spreads down to 338 bps over Treasuries – levels reached only once before the global financial crisis of 2007-8. That’s all the more telling since these spreads have fallen as the Fed has hiked its short-term rates – reacting to the same business conditions that have allowed the Fed to start raising rates.

 

Source: Bloomberg and Legg Mason, March 7, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


It’s important to note that as HY spreads fall, yields have risen: the yield-to-worst for the Bloomberg Barclays US HY Index is 6.16% as of March 7, 2018 – and the index has produced a total return of 4.05% in the 12 months ended March 6, 2018.

Not surprisingly, calendar 2018 has been less kind; the HY index total return from 12/28/2017 to 3/6/2018 was -0.41%. But compare that to the US Aggregate Index, which produced a total return of -2.15% for the same period.

To learn more about how active rate management can contribute to total return, read Legg Mason’s Active Management – How It Works

 

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