Quarterly Update

Oct. 2019

Gregory S. Kaplan, Director of Fixed Income, Managing Director | Oct. 2019

Fixed Income Outlook Positive Despite YTD Gains

We expect one or two more quarter point cuts in the Fed Funds rate this year, followed by another cut in 2020.

Intense media-driven concern about the inverted yield curve belies the statistics that indicate the time from inversion to recession varies widely.

We further note that while the U.S. Treasury yield curve is inverted (in places), the corporate and municipal bond curves remain steep, providing opportunities to extend duration for clients seeking to preserve income as the Fed lowers short-term rates.

In early 2019 we posited that fixed income returns would improve from 2018, with a tailwind from the global deceleration. We were right… but what we didn’t see at that point was the sharp, Twitter-induced escalation of the trade war that further damaged confidence globally, drove some trade-reliant economies (e.g., Singapore, Germany) to zero or negative growth, and produced strong returns among safe assets. The resultant dovish shift in the Fed’s tone ultimately led to two rate cuts during the quarter. We expect one or two more quarter point cuts in the Fed Funds rate this year, followed by another cut in 2020 (see chart). This suggests that despite a sharp drop in yields YTD, tailwinds to fixed income performance are likely to persist in the short to medium term.

Yields on as much as 25% of the global bond market were negative during the third quarter(see chart). Interestingly, the majority of negative yields shifted from Japan to Europe as expected further easing by the European Central Bank was priced into the market. While lower European rates have had their intended impact of increasing loan growth, they have also increased the household savings rate, which has been counterproductive. Because they encourage net capital savings, we view negative rates as a long-term headwind for the European economy. Back at home, the U.S. dollar and rates markets continue to attract global capital, enabling our increasing deficit financing needs and serving to keep rates lower than domestic growth would otherwise suggest.

Intense media-driven concern about the inverted yield curve belies the statistics that indicate the time from inversion to recession varies widely. In the last instance, it was roughly 2 ½ years between inversion and the financial crisis. While we believe the inversion is meaningful and bears watching, we also think the glide slope is long and the risk of domestic recession over the next 12 months is low. We further note that while the U.S. Treasury yield curve is inverted (in places), the corporate and municipal bond curves remain steep, providing opportunities to extend duration for clients seeking to preserve income as the Fed lowers short-term rates.

Key Points

We expect one or two more quarter point cuts in the Fed Funds rate this year, followed by another cut in 2020.

Intense media-driven concern about the inverted yield curve belies the statistics that indicate the time from inversion to recession varies widely.

We further note that while the U.S. Treasury yield curve is inverted (in places), the corporate and municipal bond curves remain steep, providing opportunities to extend duration for clients seeking to preserve income as the Fed lowers short-term rates.

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Important Disclosures

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change.

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources, and, although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed.

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change.

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