Reversal of Fortune
Risk sentiment has improved significantly since the start of the month as greed has won over fear, despite what we think has been a minimal change in the investment landscape. The primary themes of slowing global growth, low-inflation concerns, the stronger USD and the potential for currency wars, along with the litany of global hotspots, remain largely in place in our view. To be sure, the recent stability in oil prices has taken one of the primary edges from the market, while Greece has also reached yet another resolution with its creditors. We would note, however, that crude is mostly unchanged for the month, down over 9% on the year, and less than half of what it was versus last summer. We also call the agreement reached with Greece hardly a victory, at least from the Greek and non-euro denominated world as the Country's growth profile has not changed and the perennial can has once again been kicked. In fact, given that the agreement provides only a temporary four month grace period, we have no doubt that we will be writing about Greek dramas and tragedies again. For the moment at least, the market has once again put on its old comfortable risk-on glove, with U.S. equities once again establishing new highs as rates have returned over half of their January gains. Given that we think the ongoing themes of monetary divergence remain in place, we are hesitant to signal the all clear and point to the continued outperformance of many asset classes that are directly buoyed by dovish central bank action and rhetoric. In particular, many European bourses are up over 10% for the year, while the Nikkei and Australian bourses also have YTD gains in excess of 6%. This compares to the 1-3% YTD gains for U.S. stocks. While we interpreted the Fed minutes and part one of Yellen's congressional testimony as more dovish leaning, the focus remains on when lift-off will occur, not if the FOMC will pull the trigger. From this perspective, the odds of a June rate hike continue to diminish, although we continue to think that Sept/Oct is the most likely outcome.
BNY Mellon Weekly Fixed Income Market Commentary - February 26, 2015 February 26, 2015 20150226

BNY Mellon Weekly Fixed Income Market Commentary - February 26, 2015

Reversal of Fortune
Risk sentiment has improved significantly since the start of the month as greed has won over fear, despite what we think has been a minimal change in the investment landscape. The primary themes of slowing global growth, low-inflation concerns, the stronger USD and the potential for currency wars, along with the litany of global hotspots, remain largely in place in our view. To be sure, the recent stability in oil prices has taken one of the primary edges from the market, while Greece has also reached yet another resolution with its creditors. We would note, however, that crude is mostly unchanged for the month, down over 9% on the year, and less than half of what it was versus last summer. We also call the agreement reached with Greece hardly a victory, at least from the Greek and non-euro denominated world as the Country's growth profile has not changed and the perennial can has once again been kicked. In fact, given that the agreement provides only a temporary four month grace period, we have no doubt that we will be writing about Greek dramas and tragedies again. For the moment at least, the market has once again put on its old comfortable risk-on glove, with U.S. equities once again establishing new highs as rates have returned over half of their January gains. Given that we think the ongoing themes of monetary divergence remain in place, we are hesitant to signal the all clear and point to the continued outperformance of many asset classes that are directly buoyed by dovish central bank action and rhetoric. In particular, many European bourses are up over 10% for the year, while the Nikkei and Australian bourses also have YTD gains in excess of 6%. This compares to the 1-3% YTD gains for U.S. stocks. While we interpreted the Fed minutes and part one of Yellen's congressional testimony as more dovish leaning, the focus remains on when lift-off will occur, not if the FOMC will pull the trigger. From this perspective, the odds of a June rate hike continue to diminish, although we continue to think that Sept/Oct is the most likely outcome.


Credit has been one of the bigger beneficiaries of the renewed risk appetite this month, posting excess returns as IG spreads and HY levels have returned to November 2014 levels. Investment grade spreads have benefitted from their negative correlation with rates, with index spreads below +130 for the first time since mid-December on the heels of the 35 bps backup in 10-year treasury yields this month. These gains have occurred despite yet another +$100 billion month for new issues, which included a relatively quiet holiday-shortened week last week. As if making up for lost time, we have already had $20 billion in deals this week, and this month is set to be the busiest February on record. Looking ahead, March issuance has averaged $120 billion over the past three years, so expect primary market activity to remain an active story within the IG space. We are not particularly constructive on IG spreads, however, as we think that we are moving back towards the middle of a 1.80%-2.20% range for the 10-year, without much market conviction to push rates much higher. From this perspective, squeezing more treasury driven spread compression may prove difficult, while recent observations point to more swap activity around new issues, as accounts may no longer be as flush with start of the year cash balances.



High yield has moved from worst to first over the past month, reversing over 200 bps of negative excess return to become one of the few domestic fixed income asset classes posting a positive total return this month. The stability of oil has helped drive investor interest back into the sector, with three consecutive weeks of +$2 billion in fund flows, making it the strongest move into HY in well over a year. The move back into high yield could potentially still be in the earlier stages, as the spread of double-B credits are presently 30 bps rich to last year's average index levels, while single-B credits are still 20 bps cheap. Given the recent and ongoing concerns with energy credits, the triple-C sector continues to lag from an absolute and relative perspective, which we don't envision reversing in the near term. From this perspective, while continued positive flows should support a down in credit trade, we would limit our exposure to moderately risky single-B credits at the moment.

As the economic table below indicates, there will be no lack of economic data in the upcoming week. Inflation headlines will continue to drive concerns over slowing price growth, as headline CPI and PCE are both expected to be negative. Core numbers are expected to be just barely positive, so it will be difficult to spin inflation concerns unless there are large upside surprises. The second revision to 4Q:14 GDP will also likely prove to be a disappointing headline, with expectations set at 2%, a downward revision from 2.6% from the initial release. We will also get Michigan confidence, ISM, durable goods and monthly auto sales. Of course, all this will lead to February's nonfarm report a week from this Friday. At this point, employment expectations remain solid with payroll gains in the 250,000 range, while the unemployment rate is expected to drop slightly. Last month's employment report proved pivotal in driving an improvement in risk sentiment, and we expect this report to have equal importance. Recent economic data has been generally disappointing as the surprise index chart below indicates, so we go into this avalanche of data from a nervous perch. Interestingly, European data has generally surprised to the upside recently, allowing the Euro to firm and the USD to trade sideways over the past few weeks.





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