April 1, 216 Fixed income market update Taplin, Canida & Habacht, LLC BMO Global Asset Management 11 Brickell Bay Drive Suite 21 Miami, Florida 33131 p 35-379-21 f 35-379-4452 tchinc.com
Fixed income market update For the quarter ended March 31, 216, the Barclays U.S. Aggregate Bond Index (BCAGG) returned 3.3%. U.S. Treasuries returned 3.2% during the quarter as the yield on the 1-year U.S. Treasury declined to 1.77% from 2.27% at the end of December. For the quarter, long Treasuries (8.15%) significantly outperformed intermediate Treasuries (2.35%) as the yield curve flattened. Mortgage-backed securities (MBS) returned 1.98% during the quarter, underperforming duration-matched Treasuries by 38 basis points. The option adjusted spread (OAS) of the Barclays U.S. Mortgage Index tightened 2 basis points during the quarter to end the period at 22. (%) (bps) 4.5 4. 3.5 3. 2.5 2. 1.5 1..5. 25 2 15 1 5-5 -1 Fixed Income Sectors Total Returns 3.2 3.2 3.3 3.3 3.61 3.61 2.52 3.92 3.92 2.4 2.4 1.98 1.98.16.92.2.12 1.36 1.36 1.25.3 Treas. U.S. Agg. Agencies ABS CMBS MBS Credit 1-Mo 3-Mo YTD (3/31/216) Fixed Income Sectors Excess Returns 236 15 76 58 58 4 12 12 16 16 15 18 18-4 -4-6 -38-38 U.S. Agg. Agencies ABS CMBS MBS Credit 1-Mo 3-Mo YTD (3/31/216) 1
Fixed income market update (continued) Credit securities returned 3.92% for the quarter, outperforming Treasuries by 18 basis points on a duration-adjusted basis. The OAS of the Barclays U.S. Credit Index ended the period at 155 bps, 1 basis point tighter than at the end of December. For the quarter, long credit (6.82%) outperformed intermediate credit (2.7%) by 1 basis point on a duration-adjusted basis. For the quarter, on a duration-adjusted basis, industrials outperformed non-corporates, utilities and financials by 43, 57 and 162 basis points of excess return, respectively. BBB rated securities outperformed AAA, AA and A rated securities by 44, 35 and 33 basis points of excess return, respectively. High yield delivered 77 basis points of excess return for the quarter. (%) (bps) 6.3 5.3 4.3 3.3 2.3 1.3.3 -.8-1.8-2.8 4 35 3 25 2 15 1 5-5 -1-15 4.71 4.71 3.49 1.26 4.98 4.98 Subsector and Quality Total Returns 1.72 2.26 2.26 1.39 3.68 3.68 2.51 2.51.5 1.47 3.7 3.7 2.2 3.89 3.89 3.66 4.33 4.33 Industrial Utility Financial Non-Corp Aaa Aa A Baa 1-Mo 3-Mo YTD (3/31/216) Subsector and Quality Excess Returns 333 35 187 155 114 123 131 7 7 39 13 27 27 6 32 39 13 4 4 6-5 -5-92 -92 Industrial Utility Financial Non-Corp Aaa Aa A Baa 1-Mo 3-Mo YTD (3/31/216) 2
Economic update Fourth quarter 215 gross domestic product (GDP) was revised higher to 1.4% from the previous reading of 1.%, continuing improvement since the initial estimate of.7%. In the most recent estimate, consumer spending was revised higher from 2.% to 2.4% growth for the fourth quarter. For the full year 215, consumer spending grew at 3.1%, the highest level of growth in ten years. The Atlanta Fed s GDPNow estimate for the first quarter 216 growth is.6%. Percentage (%) 6 4 2-2 -4-6 -8-1 Mar 7 Sep 7 Mar 8 Sep 8 Mar 9 Gross Domestic Product (GDP) Sep 9 Mar 1 Sep 1 Mar 11 Sep 11 Mar 12 Sep 12 Mar 13 Sep 13 Mar 14 Sep 14 Mar 15 Sep 15 Nonfarm Payrolls MOM (net) Source: Bureau of Economic Analysis Thousands () 6 4 2-2 -4-6 -8-1 Jan 7 Jul 7 Jan 8 Jul 8 Jan 9 Jul 9 Jan 1 Jul 1 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Nonfarm payrolls rose by 215, jobs in March slightly exceeding expectations with minor revisions to the prior two months. The unemployment rate rose.1% to 5.% as workforce participation increased.1% to 63.%, the highest level in two years. Wage growth, as measured by hourly earnings, rose.3% in March after declining by.1% in February, which had been the first decline in over a year. Source: Bureau of Labor Statistics 3
Economic update After falling as low as $26 a barrel in February, oil continued the rebound begun in mid-february during March. Oil prices rose over 1% in March reflecting improved market views on global growth, aggregate demand and a weaker U.S. dollar. After the Bloomberg Dollar Spot Index peaked in January, the dollar has declined over 5%. The current index level is the lowest since June 215. 16 14 12 1 8 6 4 2 Oil (WTI CRUDE FUTURE) Consumer Price Index (YoY) Percentage (%) 6 5 4 3 2 1-1 -2-3 Jan 7 Jul 7 Jan 8 Jul 8 Jan 9 Jul 9 Jan 1 Jan 7 Jul 7 Jan 8 Jul 8 Jan 9 Jul 9 Jan 1 Jul 1 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Source: Bloomberg Jul 1 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 The Consumer Price Index (CPI) in the U.S. declined by.2% in February. However, Core CPI which excludes food and energy, rose.3% in February and 2.3% year over year. In Europe, concerns of deflation remain high with a -.1% CPI year over year in March following a -.2% inflation in February. Core inflation in Europe, which had been below 1% in February rose to 1.% in March. US CPI Eurozone CPI Source: Bureau of Labor Statistics, Eurostat 4
Economic and market perspective At the long anticipated European Central Bank (ECB) meeting in March, the central bank delivered a significant package of monetary stimulus. The ECB lowered three interest rates, including cutting the deposit rate from -.3% to -.4%. The ECB enlarged its quantitative easing program by increasing monthly direct asset purchases from 6 billion to 8 billion and expanded the definition of eligible assets to include investment grade non-financial corporate debt. For financial institutions, the ECB initiated another program of low cost loans to encourage lending to end borrowers. The package exceeded market expectations in its breadth and depth. However, by comparison to the promise of no limits, President Draghi disappointed markets with the realization that rates might not move much further into negative territory, effectively conceding there are some limits to ECB policies. The impact of the ECB s policy package to European credit markets was immediate. The 3.6 billion issuance of corporate debt sold in the week following ECB s announcement was nearly 5% higher than the previously weekly record of 21.5 billion, which was set in May 214. Similarly, the Bank of Japan s (BOJ) quantitative easing and negative deposit rates have had significant impacts. At the end of March approximately 7% of Japanese sovereign debt was trading with negative yields, including the benchmark 1-year bond. The magnitude of the program is such that the BOJ owns approximately 1/3 of outstanding Japanese Government Bonds (JGB). The Chinese government released its newest five year plan in March, which included setting the target growth rate at 6.5% or above for the next five years. During the month, both S&P and Moody s lowered their outlook on China s debt from stable to negative in March. On April 1, the official Purchasing Managers' Index (PMI) rose to 5.2 in March, the first expansionary level since July 215. The Caixin manufacturing PMI also rose significantly in March, marking the first increase from the previous month in a year. The level closed at 49.7, increasing from 48. in February. 5
Economic and market perspective While not implementing any policy changes, the Fed released a new dot plot at its March 15-16 meeting, which showed the reduction of expectations for additional rate hikes from four to two this year. At the same time, Fed Chair Janet Yellen indicated that April remains a live meeting in terms of rate hikes. Subsequent to the March meeting, several Fed officials appeared to support further hikes in the near term. However, in a speech to the Economic Club of New York on March 29, Chair Yellen appeared to reverse course, telling the audience that it was appropriate for the Committee to proceed cautiously in adjusting policy. Noting the added risks from global economic and financial conditions since the beginning of the year, Chair Yellen suggested that the Fed had sufficient ability to increase policy accommodation should it be necessary. In our view, fixed income performance in March illustrates how quickly markets can rebound after a period of dislocation and further highlights the difficulty in timing markets. Deteriorating market sentiment from the second half of 215 and the beginning of 216 shifted quickly to more sanguine market conditions and a more fundamental valuation of risk. Between reasonable U.S. fundamentals, the Fed s affirmation of its accommodative stance and increased accommodation abroad, U.S. fixed income market continues to be well supported and the substitution effect remains in effect. We expect these factors to keep U.S. interest rates range-bound and support high quality U.S. fixed income more broadly, including mortgage backed securities (MBS) and credit. The improved market outlook was furthered by the actions of the European Central Bank (ECB), which has continued to reshape the fixed income environment well beyond the borders of the Eurozone. By not only lowering its deposit rate further into negative territory and expanding the size of its quantitative easing program, but purchasing corporate debt, the ECB has magnified and broadened the substitution effect to support corporate spreads. The substitution effect takes on another level for multi-national corporations, who may seek to issue in Euros to benefit from the lower cost of borrowing; this location shopping could alleviate some of the high issuance in the U.S. market, which has been a headwind to credit spread tightening. Given the magnitude of mispricings over the prior quarters, even with the tightening of spreads in the first quarter, credit spreads remain wide in a historical context. The credit sector as a whole remains attractive, with certain segments and sectors remaining more meaningfully dislocated offering a deep opportunity set for investment. 6
Fixed income returns as of March 31, 216 Index Returns as of March 31, 216 Total Return (%) Excess Return (%) Month-to-Date Quarter-to- Date Year-to- Date Month-to-Date Quarter-to- Date Year-to- Date U.S. Aggregate.92 3.3 3.3.76 -.4 -.4 U.S. Treasury.16 3.2 3.2 - - - Intermediate.19 2.35 2.35 - - - Long. 8.15 8.15 - - - TIPS 1.8 4.46 4.46 - - - Agencies.2 2.4 2.4.4.12.12 U.S. MBS.3 1.98 1.98.15 -.38 -.38 U.S. Credit 2.52 3.92 3.92 2.36.18.18 Intermediate 1.57 2.7 2.7 1.37.17.17 Long 4.77 6.82 6.82 4.71.18.18 Industrial 3.49 4.71 4.71 3.33.7.7 Utility 1.26 4.98 4.98 1.14.13.13 Financial 1.72 2.26 2.26 1.55 -.92 -.92 Non-Corporate 1.39 3.68 3.68 1.23.27.27 Aaa.5 2.51 2.51.32 -.5 -.5 Aa 1.47 3.7 3.7 1.31.4.4 A 2.2 3.89 3.89 1.87.6.6 Baa 3.66 4.33 4.33 3.5.39.39 High Yield 4.44 3.35 3.35 4.26.77.77 Floating Rate Notes.22.21.21.18.12.12 7
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