April 4, 2018


Federal Reserve policymakers raised the federal funds rate 25 basis points in March, but inflation breakeven rates fell during the month and this led to a flatter U.S. Treasury yield curve.  This dynamic was positive for our fixed income portfolios as we incrementally extended duration in February to take advantage of higher yields available in the market after Treasury prices fell earlier in the year.


U.S. Treasury Yield Curve

 Source: Bloomberg


Investors were optimistic about the economy’s prospects in the aftermath of the passage of the ‘Tax Cuts and Jobs Act’ in the United States late last year, but that optimism has turned into considerable angst as president Trump turned his attention to trade arrangements during the last several weeks.  Fears of further escalation of trade rhetoric from global leaders, combined with uncertainty regarding how this conflict will play out over the longer run, have undoubtedly had an important impact on the fixed income market in recent weeks.  Falling inflation breakeven rates, higher corporate spreads, and lower yields on the long end of the Treasury yield curve are all (at least in part) a response to this increased worry.


Corporate spreads rose in March, consistent with the increased volatility seen in the equity market.  Even after this move, however, spreads are fairly tight, with room to widen further if investor worry continues to increase.


Barclays Baa-Rated Adjusted Spread

    Source: Bloomberg


Inflation breakeven rates rose considerably from last summer to the end of February, but fell in March.  They too could fall further in the coming weeks if headlines remain fairly bleak.


U.S. Inflation Breakeven Rates

             Source: Bloomberg


Finally, it is important to mention the Libor – OIS spread, which measures the difference between the U.S. dollar 3-month LIBOR rate (at which London banks lend to each other) and the 3-month U.S. dollar swap rate.  The Libor – OIS spread has jumped in recent weeks, climbing to its highest level since 2009.  Many analysts are blaming the rise on increased issuance of short-term U.S. Treasury notes and the repatriation of cash back to domestic banks in the aftermath of tax reform in the U.S.  The possibility also exists, however, that the increased spread is indicative of some additional stress beginning to form in the credit markets.


LIBOR – OIS Spread

             Source: Bloomberg


We are forecasting that the U.S. Treasury yield curve will continue to flatten, with the short end of the curve rising as the Federal Reserve continues to raise the federal funds rate, and the long end declining modestly.  Consistent with this view, within our fixed income strategies we are maintaining durations slightly longer than those of corresponding benchmarks.  Additionally, we are watching corporate spreads closely and plan to increase our exposure to corporate bonds (where permitted by client mandate) if and when spreads widen significantly from current levels.


Brandon Fitzpatrick




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