U.S. Fixed Income

February 2020 Fixed Income Market Update

In our view, the recent market jitters should not be interpreted as a significant negative shift for markets or the U.S. economy.
February 2020

Economic and market perspective

As we began 2020, long-standing geopolitical concerns (China trade, Brexit) faded only to be replaced with others. Brief escalation of tension in the Middle East and then concerns surrounding the coronavirus contributed to risk-off sentiment in the month. These sentiments were amplified by the softening of U.S. economic data.

The coronavirus came to the fore in January, spreading rapidly in China and beginning to appear globally. As of the end of January approximately 14,000 cases had been reported with approximately 300 deaths. In addition to fears of the outbreak worsening, prophylactic measures to prevent further contagion are expected to have negative short-term impacts on Chinese growth and the global economy. Over the weekend after month end, the People’s Bank of China (PBoC) announced it would inject an additional 150 billion yuan into money markets on February 3 to support liquidity during the outbreak and help calm market fears – the largest single day action to date. Earlier in January, the PBoC lowered  reserve ratios by 50 basis points, freeing up approximately 800 billion yuan ($115 billion) for new loans.

The United States and China signed the “phase one” trade agreement on January 15th as expected. Two days prior to the official signing, the U.S. removed China from the list of currency manipulators based on commitments in the trade deal. China’s economy grew at a 6.0% rate in the fourth quarter and 6.1% for 2019, matching expectations.

The United States-Mexico-Canada Agreement (USMCA) was officially approved by the U.S. Senate and signed by President Trump in January. While the month was largely marked by de-escalation of trade concerns, in Davos, Commerce Secretary Wilbur Ross suggested the U.S. would revisit initiating tariffs on imports of European cars. These tariffs had been previously considered and tabled in early 2019. The move is viewed as intended to push the E.U. to engage regarding a new trade deal.

After years of inducing market volatility, Brexit happened rather quietly at the end of January. The U.K. officially exited the European Union on January 31 though negotiations with the E.U. will persist. The U.S. is looking to negotiate a trade agreement with the U.K., but it cannot go into effect until the end of the U.K.’s transition period from the E.U, currently scheduled for the end of 2020.

As expected, the Federal Open Market Committee left the Fed Funds rate unchanged at its January 28-29th meeting. The statement reflected few changes from the prior statement, with the most notable tweak being around inflation language. In their December statement the Fed had referred to current policy as appropriate to support “inflation near the Committee’s symmetric 2% objective.” In the January statement they revised this phrasing to indicate current policy was appropriate to support “inflation returning to the Committee’s symmetric 2% objective.” In the press conference,  Chairman Powell explained that the adjustment was made “to underscore our commitment to 2% not being a ceiling, to inflation running symmetrically around 2% and we’re not satisfied with inflation running below 2%.” The Fed also raised the interest on excess reserves rate by 0.05% to 1.60%. As of the end of January, the market is pricing approximately a 50% probability of a rate cut at the April meeting and one additional cut before year end. By contrast, at the end of December the projection was for no cuts in 2020.

The U.S. Treasury will begin issuing 20 year bonds later in the year after studying options to deal with growing fiscal deficits, including longer dated 50 or 100 year bonds. 20 year bonds had previously been issued from 1981 through 1986, but were discontinued due to lack of demand.

Outlook and conclusions

In our view, the recent market jitters should not be interpreted as a significant negative shift for markets or the U.S.  economy. Rather the recent volatility is a healthy re-appreciation of risk after markets had grown too optimistic, particularly as China trade and Brexit faded from focus. We do not expect the worst of coronavirus fears to be realized and view impacts as short term rather than long term or structural. Nonetheless, this type of event is reminder of the potential for surprises and market vulnerability when risk sentiment grows as strong as it had toward the end of 2019. Our fundamental views of reasonable U.S. economic data and accommodative monetary policy remain in tact, which we view as strong supports for non-governmental sectors in fixed income. The recent fear  has pushed Treasury yields within sight of all-time lows set in 2016. While tempting to view current levels as overdone given the current state of the economy, sufficient supports from global demand remain and risk-off sentiment could easily grow further, which could push rates even lower. In sum, we welcome recent moderate spread widening and continue to favor non-governmental sectors given the decline in Treasury yields.

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