'Risk-on' is back in the credit markets
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.