'Risk-on' is back in the credit markets 'Risk-on' is back in the credit markets http://www.federatedinvestors.com/static/images/fed-logo-amp.png March 15 2019

'Risk-on' is back in the credit markets

January's rally was particularly strong across fixed-income credit sectors. With spreads narrowing, momentum could ease in the months ahead. But the outlook remains positive.
Published February 6 2019
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Like our equity brethren, fixed-income is experiencing a sharp reversal of December’s strong “risk-off” move, with credit sectors generally and high yield and emerging markets (EM) in particular off to a muscular start to 2019. So much so that the spread between credit issues and comparable maturity Treasuries has narrowed considerably so far this year. This could cause momentum in the credit markets to ease in the months ahead, which is why our fixed-income sector committee this week voted to slightly reduce Federated’s recommended overweight to high yield. That said, the committee remains positive on high yield and other major fixed-income credit sectors (EM, investment-grade corporate bonds and commercial mortgage-backed securities) where it also has overweight recommendations. The reason? Conditions fueling “risk-on” are unlikely to change anytime soon, primarily for three key reasons:

  • The Fed has backed off. After conflicting if not a touch hawkish signals at December’s meeting, Federal Reserve (Fed) policymakers have made a notable dovish turn, signaling they are going to be “patient” with future rate increases and that balance-sheet reduction could be adjusted, too. This could change if inflation starts to pick up, but the data since last February suggest core PCE inflation measures have been and are likely to continue to stick around the Fed’s 2% target for the foreseeable future. Furthermore, based on recent Fed speeches, seeing inflation rise above the 2% target now seems to be a desired outcome—a significant shift in the Fed’s reaction toward inflation.
  • Recession talk has died off. We never believed the U.S. economy was at threat of an imminent downturn, but strong job growth and generally good news on manufacturing and services activity have made clear this is a non-issue for the next few quarters at least.
  • China and the U.S. are making nice. Even if the two sides kick the can down the road before their self-imposed March 1 deadline, both sides are sounding promising notes that some sort of trade truce is likely. Both countries could use it. China’s economy is expanding at its slowest pace in 30 years. And while the macro situation isn’t as critical in the U.S., with the 2020 presidential election season starting to heat up, President Trump could use a victory after suffering at the polls from the recent record-long government shutdown.
Tags Fixed Income . Markets/Economy .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond credit ratings measure the risk that a security will default. Credit ratings of A or better are considered to be high credit quality; credit ratings of BBB are good credit quality and the lowest category of investment grade; credit ratings of BB and below are lower-rated securities; and credit ratings of CCC or below have high default risk.

Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices.  In addition, fixed income investors should be aware of other risks such as credit risk, inflation risk, call risk and liquidity risk.

Diversification and asset allocation do not assure a profit nor protect against loss.

High-yield, lower-rated securities generally entail greater market, credit/default and liquidity risks and may be more volatile than investment-grade securities.

International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. Prices of emerging-market and frontier-market securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets.

Personal Consumption Expenditure (PCE) Index: A measure of inflation at the consumer level.

The value of some mortgage-backed securities may be particularly sensitive to changes in prevailing interest rates, and although the securities are generally supported by some form of government or private insurance, there is no assurance that private guarantors or insurers will meet their obligations.

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