Macro Monitor
10-Year: No December Taper, Back To The 250 Level
Given our assumption of no December taper and the fact that most of the recent rise in interest rates is due to an early-taper fear, we expect the 10-year yield to drop back to the 250 level.
The Dual Mandate Presents A Clear Dilemma For The Fed
The “dual mandate,” which means the Fed is paying close attention to both inflation and employment, presents a clear dilemma for the Fed when it comes time to decide on a taper.
US Bond Market - October 2013
We are encouraged by the narrower spreads in October as the feared divergence between credits and equity markets did not continue.
Risk Aversion Index Falls Further, Stays On Its “Lower Risk” Signal
We seem to be in a “Goldilocks” period, where economic numbers are not bad enough to re-ignite recession fears but are just weak enough to push the taper farther off.
Five Reasons Inflation Is Still Missing
Overall demand slack, stubbornly low velocity of money, an overall stronger dollar, painfully low labor cost inflation and weakness in commodity prices are strong disinflationary forces.
10-Year: Year-End Target Still 250 BPS, Interim Volatility Expected
We don’t think the numbers between now and the Fed’s December meeting will be strong enough to convince it to start tapering this year. No taper until 2014, in our opinion.
Our Position on U.S. Bonds
U.S. Investment Grade Corporate Bonds: Favorable, U.S. High Yield Corporate Bonds: Neutral, U.S. Municipal Bonds: Neutral
Risk Aversion Index Falls To New “Lower Risk” Signal
The RAI had the biggest drop of the year in September and triggered a new “Lower Risk” signal. This is largely due to the no-taper decision by the Fed. We remain cautious in the near term due to the debt ceil- ing debate but recommend increasing risky exposure after the debt ceiling resolution.
Inflation Still Going Nowhere In The U.S.
Inflation at both consumers’ and producers’ level is still modest. A drawn out government shutdown and debt ceiling debate will hurt the economy, which could further push out the taper timeline.
Debt Ceiling—Weakness Before But Strength After Resolution
A look at prior debt ceiling debates and patterns around resolution dates gives no surprises: markets are weaker in the two weeks before but stronger in the month after a resolution is reached.
No Taper—More Downside Likely On The 10-Year & Higher Volatility Ahead
A look at prior debt ceiling debates and patterns around resolution dates gives no surprises: markets are weaker in the two weeks before but stronger in the month after a resolution is reached.
Data Dependency—September Taper Still Likely
More upside surprises are still likely and, despite the disappointing jobs report, the overall economic picture still supports a September taper. The improving economic picture is not just happening within the U.S., but in other major countries. We still believe the upside for the U.S. 10-year is limited.
RAI Falls, But Stays On “Higher Risk” Signal—Remain Cautious
The RAI fell in August and stayed on a “High Risk” signal. We remain cautious and recommend higher quality within fixed income.
U.S. Investment Grade Corporate Bonds: Maintain Favorable
This is consistent with our overall cautious view on credits. Credit spreads continued narrowing despite higher volatility in the bond markets.
U.S. High Yield Corporate Bonds: Maintain Neutral
On the positive side, the fundamental picture is still healthy for most U.S. high yield issuers, and defaults are expected to be low. On the negative side, weakening inflation expectations is a divergence that bears close monitoring. We will exercise patience and wait for a better entry point.
U.S. Municipal Bonds: Maintain Neutral
Their relative cheapness, combined with the prospect of higher tax rates, certainly makes Munis more attractive now. But we’ll wait for interest rate volatility and outflows to subside before turning bullish on Munis.
10-Year: Taper the Taper—Upside Limited
If interest rates keep going higher from here, we would run the risk of derailing a still-fragile recovery. As long as the Fed tapering uncertainty exists, we expect higher volatility on the 10-year yield to persist in the mean time.
The Dollar: Upside Limited In The Near Term
A closer look at the dollar’s two main counterparts, the euro and the yen, reveals a regime shift in both cases, but for different reasons.
RAI Fell, But Stayed On “Higher Risk” Signal—Remain Cautious
The RAI fell in July and stayed on a “High Risk” signal. We remain cautious and recommend higher quality within fixed income.
U.S. Investment Grade Corporate Bonds: Maintain Favorable
Despite the exodus from all bond classes in the last few months, longer term demand for safe spreads is likely to remain strong and investment grade issuance has dropped significantly.
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