In a volatile year, interest rates started 2016 by declining rapidly due to fears that global deflation – emanating from slowing economies in Europe and China – would infect the US economy. Additionally, investors speculated that the Fed, as indicated from its December 2015 meeting, would only add to this strain by maintaining a steady rate of increases in interest rates. The thought process was that the US dollar would increase in value, hurting the export-led economy of China, whose currency is pegged to the dollar. This would force them to devalue the yuan faster than desired, thus starting a worldwide deflationary spiral.
Fed officials got the message and decreased their rate expectations. Corporate debt, shunned by the prospect of slowing economies, witnessed a dramatic turnaround as investors grew comfortable that the Fed would not make a mistake.
As economic data continued to support a “go slow” approach for the Fed, politics, especially European politics, took center stage. The decision by the UK to exit the European Union led investors to fear not only that the UK will enter a recession, but also that Europe as a whole may be the biggest loser. The vote also pointed to a rise in nationalism, and with it more restrictive trade policies. As such, investors concluded that global economic conditions would slow and that the world’s major central banks would have to increase various forms of easy monetary policies. Interest rates declined precipitously, touching record low yields on the 10-year and 30-year Treasuries (1.359% and 2.099 respectively) on July 8th.
That was the low point for yields as investors began to question the efficacy of monetary policy. This movement began in Japan as the Bank of Japan said they needed to review their policy of asset purchases.
As rates slowly moved higher over the late summer and early fall, the US elections took center stage. In a year when populist voters reshaped power, politics, and the investment markets across Europe, the US now took its turn. The election of Donald Trump as President, and with control of both houses of Congress remaining in Republican hands, market psychology quickly changed. Yields moved quickly higher and the yield curve steepened as investors anticipated a more expansive fiscal policy in the US. Additionally, the belief Trump would follow through on his pledge to lower taxes and increase spending on infrastructure, both of which could intensify inflation and increase the budget deficit further, fueled the move to higher rates.
The events of the 4th quarter only amplified the global narrative that questions the efficacy of non-traditional monetary policy (asset purchases) and the ensuing pivot toward fiscal stimulus. Citing the changing dynamics and the impact of potential fiscal stimulus, the Fed raised the target Fed Funds rate 25 basis points in December from a range of 0.25%-0.50% to 0.50%-0.75%.
As we enter 2017, markets are convinced that President-elect Trump will bring higher economic growth and higher inflation. As such, Treasury yields, which were whipsawed this year, are closing slightly higher on a year-over-year basis. The increase is being led by higher inflationary expectations. After a rough start, corporate bonds performed very well as anticipation of fiscal stimulus is expected to hold off recessionary fears. And municipal bonds suffered greatly in the 4th quarter, wiping out all of the year’s gains on Trump’s pledge to cut taxes.
Brian is a Vice President and Senior Portfolio Manager who manages the fixed-income investment process for Wealth Management & Advisory Services clients by providing sophisticated investment counsel and portfolio risk control strategies. Brian is the bank’s primary fixed-income strategist and oversees the strategy, implementation and trading of all fixed-income securities for both private and institutional capital. Brian also holds a Chartered Financial Analyst designation. He has more than 20 years of portfolio management and institutional investment experience. Brian's significant expertise in fixed income is a key to our clients’ financial success, as he positions them to both safe and well positioned portfolios.