U.S. Fixed Income

September 2019 Fixed Income Market Update

In our view, though market focus has been on the reinvigorated trade dispute between the U.S. and China as well as the monetary policy transition in the U.S.. lost in the mix has been resilience of the U.S. economy.
September 2019

Economic and market perspective

Trade tensions dominated market headlines during the month, while markets continued to digest the shift in U.S. monetary policy begun with the Fed’s rate cut at the end of July.

On August 1, the U.S. indicated it would add a 10% tariff on $300 billion worth of goods coming from China, with the threat to increase tariffs on $250 billion of goods up to 25% absent progress on a trade deal.  On August 6, the U.S. Treasury Department designated China a currency manipulator citing the manipulation of currency to garner “unfair competitive advantage in international trade.”  The same day, China suggested tariffs on U.S. agricultural products were a possibility and announced that many Chinese companies had ceased buying U.S. agricultural goods.  Mid-month, the U.S. announced it would delay the imposition of certain tariffs with the holiday season in mind.  On August 23, China announced tariffs on $75 billion worth of U.S. goods. In response to this announcement, President Trump announced that “American companies are hereby ordered to immediately start looking for an alternative to China.” The U.S. also announced it would increase tariffs on $300 billion worth of imports from China on September 1 and another round of increases on $250 billion of goods would occur on October 1.  Toward the end of the month, both sides appeared to call for additional talks and reconciliation, though no concrete progress was achieved.  Over the final weekend of the month, the U.S. turned down a Chinese request to delay the tariffs set to start September 1.

With a significant number of companies citing tariffs on their earnings calls, U.S. earnings declined -0.4% in the second quarter, marking the first time earnings declined for two consecutive quarters since 2016.  However, expectations had been for a sharper decline (-2.7%) and 75% of S&P 500 companies exceeded their earnings expectations, according to FactSet. Third quarter earnings are expected to decline (-3.5%) before a rebound in the fourth quarter (+3.5%) that carries into the first  quarter (+8.2%) and second quarter of 2020 (+9.3%).

Germany’s GDP declined -0.1% and overall Eurozone GDP increased +0.2% in the second quarter.  Eurozone inflation for August  was reported as 1.0%, below the European Central Bank’s (ECB) target of nearly 2%.  The lackluster economic data from Europe has reinforced market expectations of further policy easing from the ECB at their September 12th meeting.

Outlook and conclusions

Minutes from the Federal Open Market Committee’s July 30-31 meeting were released in August.  At that meeting, the Fed lowered the Fed Funds rate for the first time in a decade.  The 25 basis point cut brought the range for the Fed Funds Rate  to 2.00 – 2.25%.  The minutes referred to the July cut as a “part of a recalibration of the stance of policy, or mid-cycle adjustment,” insisting that monetary policy was not on a “pre-set course.”  The minutes also revealed a dispersion of views among the members, with “a couple” favoring a 50 basis point cut rather than the 25 basis point cut implemented and “several” favored no cut as risks had “diminished” since their June meeting.  Despite the Fed’s wording, the market is pricing in a 100% probability of a rate cut at the Fed’s next meeting on September 16-17, with a greater than 50% likelihood of  another cut at the October 28-29 meeting.

During the month, fixed income markets witnessed several new landmarks.  The U.S. 30 year Treasury set all time lows in yields, dropping below 2% for the first time.  Negative yielding debt globally exceeded $17 trillion, also a record. Agency mortgages have also witnessed a significant transition as duration has dropped meaningfully on the decline in rates.

In our view, though market focus has been on the reinvigorated trade dispute between the U.S. and China as well as the monetary policy transition in the U.S., lost in the mix has been resilience of the U.S. economy. We believe the market is too tethered to the daily machinations of the trade dispute between the United States and China as the dispute is unlikely to be resolved soon. This noise has led to moderate spread widening on non-governmental fixed income; spreads had been trending tighter on strong demand, Fed support and reasonable U.S. fundamentals. Despite slowing of economic data in the U.S., divergence between the U.S. and international developed markets remains.  Yet, the impact to interest rates has been supplanted by the monetary policy convergence and supply/demand dynamics between the two.  The weight of global negative yielding debt has been felt across the U.S. term structure as U.S. yields, even in their newly diminished form, remain attractive in a global landscape. While not cheap, non-governmental U.S. fixed income sectors offer additional yield in a yield constrained world.

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