U.S. Fixed Income

December 2019 Fixed Income Market Update

The continued resilience of U.S. economic data and improved sentiment on the trade front has moderated expectations of further monetary easing in the U.S.
December 2019
Economic and market perspective

In November, global economic data was mixed, while U.S. growth and employment data continued to surprise to the upside. China trade tensions continued to moderate, which improved risk sentiment, though resolution remains elusive.

Early in November, both the U.S. and China continued to signal positive developments on trade, leading to speculation that a phase one deal could be finalized in November. As the deal was not inked during the month, expectations have been reset to 2020. The next round of tariffs, an additional 15% on approximately $150 billion of Chinese goods, is set to take effect on December 15. This next round of tariffs may be postponed or cancelled as part of a phase one deal, however, China is pressing to have existing tariffs removed as part of the deal versus just preventing future tariff implementation. Chinese Purchasing Managers’ Index (PMI) rose to 50.2 in November after six consecutive months of contraction (levels above 50 indicate growth, below 50 indicate contraction.)

German GDP grew 0.1% for the third quarter as opposed to the expectation of -0.1%, avoiding a technical recession. However, Eurozone growth was 0.2% for the same period and 1.1% year-over-year, the weakest growth since 2013. The International Monetary Fund (IMF) projected that European growth will be 1.4% for 2019 after 2.3% growth in 2018, but will improve to 1.8% in 2020. In its projections, developed European economies are expected to grow 1.5% next year and emerging European economies are expected to grow 3.1%.

With over 95% of earnings reported, third quarter corporate earnings have declined 2.2% year-over-year according to FactSet. Though negative, this figure is less severe than the 3.7% estimated decline as of our last monthly update. The third quarter is set to be the worst year-over-year decline since the third quarter of 2016 (-3.2%).  With these results, earnings have declined for three consecutive quarters for the first time period since the beginning of 2016, even while revenues increased 3.1% year-over-year in the quarter.  Earnings are expected to continue their decline into the fourth quarter with a projection of -1.4%.  A rebound in earnings is expected in the first  quarter of 2020 (+5.3%) and second quarter (+6.7%) with full year 2020 earnings growth projected at 9.9%.

Outlook and conclusions

In November, the Federal Open Market Committee released the minutes from its October 29-30th meeting when the Fed cut the Fed Funds rate by 25 basis points. The minutes showed that most committee members believed that the rate cuts were sufficient “to support the outlook of moderate growth, a strong labor market, and inflation near the Committee’s symmetric 2% objective.” Regarding future cuts, the Fed suggested current policy “likely would remain” unchanged “as long as incoming information about the economy did not result in a material reassessment of the economic outlook.” In a cautionary note, they did flag “the downside risks surrounding the economic outlook as elevated, further underscoring the case for a rate cut” though stating that concerns over global growth and trade concerns had moderated somewhat.  As of the end of November, the market is pricing in effectively no chance of an additional rate cut at the Fed’s December 10-11th meeting and not pricing in better than a 50% probability of another cut until the middle of 2020.

In our view, the continued resilience of U.S. economic data and improved sentiment on the trade front has moderated expectations of further monetary easing in the U.S. While the economic results have been in-line with our expectations, they have exceeded the expectations of many in the market. However, U.S. data is not without concerns as confidence and manufacturing measures have weakened and continued softening of U.S. data is a reasonable baseline expectation near term.  We remain more cautious in our views regarding trade given the complex nature of the issues at play and the already prolonged negotiations.  The Fed’s easing of policy appears to have delivered liquidity as intended; it will be worth monitoring how this broad increase in liquidity translates to markets in December, given last year’s December experience.  We view the modest uptick in Treasury yields as welcome; corporate spreads are well supported at current levels, but tight to historical median levels.  This leaves neither rates nor spreads as cheap, but the combination of robust demand, recent monetary policy easing and reasonable (if softer) fundamentals, especially in a global context, continue to support U.S. fixed income.

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