Fixed Income Outlook: Sticking with slight risk-on bias
As much as we welcome it after a cold and dreary winter, spring is shaping up as a bit of a head-scratcher, economically speaking.
On the one hand, much of 2013’s first-quarter data surprised slightly to the upside—auto sales picked up, homebuilding accelerated, retail sales and consumer sentiment rose despite higher gas prices and payroll taxes, and both manufacturing and the labor market continued to expand, albeit at a more subdued pace. Yes, the March jobs report disappointed—nonfarm payroll growth of 88,000 was half estimates. But the prior two months were revised up significantly (a pattern that has been consistent throughout this recovery), pushing the average monthly gains over the three months to 168,000. Seasonal forces appeared to be a factor in holding down March’s published numbers.
On the other hand, even if the final read on March jobs ends up being closer to the three-month average, job growth continues to be subpar for a recovery on the verge of its fourth year. Moreover, ISM, Markit and regional manufacturing reports indicate factory activity may be slowing (though clearly not contracting). And while the $1.2 trillion sequester (which effectively represents only $40 billion or so of cuts in the current budget year that runs through September) doesn’t seem to have slowed the economy much yet, it didn’t kick in until March 1. It could take several months before the across-the-board reductions start to bite and generate potential multiplier effects.
Then there are the geopolitical uncertainties. North Korea is rattling its saber, again, but investors don’t seem to paying it much attention yet. The Cypriot banking crisis, however, did rattle the market’s cage, causing 10-year Treasury yields—which had broken above 2% and appeared to potentially be off to the races—to pull back. Whenever event risk rears its head, U.S. Treasuries and the dollar still are the world’s haven trade. Yields fell even further, below 1.80%, on the March jobs report, viewed as affirmation the Fed’s “QE to infinity’’ isn’t ending anytime soon. And the Bank of Japan’s unleashing of a new wave of stimulus should act further to push down rates on the long end as foreign investors see greater value in the U.S. rate structure relative to the Japanese market.
High-yield still biggest overweight
As Cyprus and the March jobs report made clear, it doesn’t take much to spawn rallies on the long end. That’s a pretty good sign the bond market still lacks conviction about the economy and remains cognizant of the Fed’s outsized influence on rates. Still, the data stream has eased some of the worries we had as the New Year began, as has a slightly more positive tone emanating out of Washington.
So where does Federated fixed-income team stand amid these cross-currents? In mid-March, the bond team adopted a slightly higher risk-on bias in its model portfolio, a position it is maintaining for now. Specifically, investment-grade corporate bonds remain at neutral and duration remains at 95% on expectations interest rates are more likely to rise than fall in the current macro environment.
The fixed-income team also is maintaining its biggest overweight position in high-yield bonds, with slight overweights in emerging-market bonds and commercial mortgage-backed securities (MBS). It remains slightly underweight in residential MBS due to valuation concerns.