July 2020 Fixed Income Market Update

News & nuggets

  • U.S. GDP was unrevised at -5.0% for the first quarter; expectations remain much worse for the second quarter (current estimate of -34.5%) with a significant rebound expected for Q3 (estimate of +20.0%). For both quarter, there is a wide range of estimates.
  • Earnings season begins in July and corporate earnings for S&P 500 companies are expected to decline 43.9% year over year in the second quarter according to FactSet, which would be the largest decline since the fourth quarter of 2008 (-69.1%) Approximately 1/3 of companies have withdrawn their earnings guidance for calendar year 2020 based on the high degree of uncertainty in the economy. Estimates are for a 21.6% decline in earnings for calendar year 2020 with revenues falling 3.9% and a rebound in earnings of 28.8% in 2021 with revenues rising by 8.5%.
  • With an existing infrastructure spending bill set to expire at the end of the third quarter, chatter around a long discussed expansion of a U.S. infrastructure spending program escalated in June. The Trump administration was rumored to announce a $1 trillion infrastructure spending program before internal opposition from Senate Republicans surfaced. Subsequently, House Democrats introduced a $1.5 trillion spending program; though there is some consensus between the parties at a high level on infrastructure, the details of the plans are likely to elicit disagreement.
  • After setting a record low in April at -144, the Citi Economic Surprise index rose to a record high of 181, reflecting the improvement of data relative to significantly lowered expectations.
  • No policy changes were announced at the Federal Open Market Committee’s June 9-10 meeting, but the Fed reiterated their intent regarding extraordinary policy supports. Chairman Jerome Powell stated: “We’re not even thinking about thinking about raising rates. So what we’re thinking about is—is providing support for this economy. We do think this is going to take some time.” In addition, the Fed indicated they would continue to buy Treasuries and Mortgages “at least at the current pace” i.e. $80 billion a month of Treasuries and $40 billion a month of agency mortgages. The Fed also began the purchase of individual corporate bonds; previously they had been purchasing corporate bond ETFs.

Outlook and conclusions

In our view, the magnitude and speed of the market recovery in the second quarter are noteworthy and potentially cautionary. Government programs have done a better than expected job in replacing individual income to date, though some programs are expected to expire in the next month, which could create challenges. The Fed and other central banks have provided extraordinary policy support – primarily in the speed and sheer size of programs, but also in the frequent tweaks to programs intended to highlight that support as risk-off sentiment appeared it might creep back into markets. The hope remains that the policies put in place, both fiscal and monetary, can bridge the  gap until the economy is back to self-sufficiency. Nonetheless, policy alone cannot solve the current difficulties and the increase in coronavirus cases at the end of June is a harsh reminder of the tremendous fundamental uncertainty that still remains.  This uncertainty can be seen in the wide dispersion of projections ranging from GDP to individual companies withdrawing earnings guidance and even questions around school re-openings in the fall. While markets broadly have recovered, certain pockets with less direct Fed support, notably more niche areas in the securitized space continue to offer significant value. Though compressed versus earlier in the quarter, we view spreads on non-governmental fixed income sectors as generally attractive in a historical context; however, the path they have taken to current levels and high degree of uncertainty gives us less clarity regarding the near-term outcomes. With this balance of broad spreads at attractive levels, record pace of new issuance and a high degree of uncertainty, we continue to recommend a judicious approach to implementation.

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This is not intended to serve as a complete analysis of every material fact regarding any company, industry or security.  The opinions expressed here reflect our judgment at this date and are subject to change.  Information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy.  This publication is prepared for general information only.  This material does not constitute investment advice and is not intended as an endorsement of any specific investment.  It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report.  Investors should seek advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized.  Investment involves risk.  Market conditions and trends will fluctuate.  The value of an investment as well as income associated with investments may rise or fall.  Accordingly, investors may receive back less than originally invested.  Investments cannot be made in an index.  Past performance is not necessarily a guide to future performance.

The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate and the risk-free rate of return, which is adjusted to take into account an embedded option. Basis points (bps) represent 1/100th of a percent (for example: 50 bps equals 0.50%).

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