Written by Pat Reilly, FactSet
With the summer blockbuster season upon us, I thought I would use two childhood classics (the original blockbusters if you will) to describe the current fixed income market environment. Please humor me as I take some liberty.
High Yield Is The Best Asset For Low VIX Environment: Goldman
Goldilocks
Monetary policy continues to position global markets for a Goldilocks scenario. I know what you’re thinking, “Pat, are you mental? Growth needs to accelerate in order to make country ABC great again!” Could growth be higher in G8 economies?
Certainly. . . but look at everything that has happened! In general (Canadian housing aside), things are neither too hot nor too cold. They are just right.
In the U.S., we saw a second rate increase from the Federal Reserve. This was expected and priced in. I expect the Fed to hold off on a third increase until the fall. More important than the rate hike was the announcement of the Fed’s plan to normalize the balance sheet. Many have cried wolf around the hike and the unwinding of QE. To them I say, “Check the porridge again.”
Yes, the yield curve is flattening while recent inflation numbers have been soft. However, we are far from a recession-signaling inverted curve. The over-communication from Team Yellen is a complete 180-degree turn from what is seen elsewhere inside the Beltway. We are at full employment and wage gains seem to be sticky (if not overly impressive). These moves position the Fed to act appropriately in the event of a future crisis. For perspective, the plan to unwind represents 25 basis points of the balance sheet every month to start. Like good barbecue, it’s low and slow.
This Goldilocks environment is seen in the U.K. and eurozone too (at least for now). Inflation in the U.K. remains above the Bank of Europe’s comfort zone; however, job growth, the demand for exports, consumer confidence, and fiscal uncertainty prevent potential tightening from occurring. In the eurozone, the party continues with ZIRP and QE policies remaining unchanged. Inflation is trending up, but still remains below the ECB’s 2% target. While Draghi confounded the market a bit heading into quarter end, I see the ECB’s over-communication as supportive of risk assets.
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