With bias on rates up, duration shifted lower
Federated’s fixed-income duration committee shifted its tactical duration positioning somewhat shorter relative to benchmark. Key factors behind this shift are:
- U.S. growth & inflation: Inflation has the wind at its back and is likely to head in the direction of the Fed’s 2% target based on rising wages, resource constraints, commodity prices and calendar effects (last year’s negative and very low monthly prints on headline CPI are about to roll off year-over-year comparisons). These pressures are building on anticipation of 2.5-3% real GDP growth in the near term, bolstered by business investment, fiscal expansion from the budget deal and a steady U.S. consumer. High debt, demographics and technology remain biased to restrain the level of overall inflation (as they have for some time), but the aforementioned cyclical forces should dominate the near-term direction.
- Fiscal policy, politics and market technicals: Fiscal policy has shifted to stimulative, with higher spending and lower taxes likely producing a widening deficit and more borrowing. Trend indicators remain clearly bearish: Treasury issuance is rising as the Fed is buying less; investor demand may retreat somewhat amid recent losses in bond funds and more attractive options on the cash front; and foreign investor demand seems to have faded a bit as well.
- The Fed: New Chairman Jerome Powell seems to be a straight talker and has enhanced confidence on the Fed outlook of gradual rate increases and rising inflation. Policymakers meet later this month and the market is pricing in near unanimity for a tightening. The press conference should offer a window on a more confident FOMC that further normalization is appropriate. The curve of median dots seems biased upwards, although it is not clear if the median long-run dot also edges higher.
Various considerations offer caution about getting too short, including the potential resurgence of risk asset volatility as market yields rise and/or as Washington events evolve—ranging from the Mueller investigation to trade tariffs.