MainStay Investments presents insights from the MacKay Shields Global Fixed Income Team, subadvisors to several MainStay fixed-income funds.
Market sentiment remained relatively subdued in February following strong performance of risk assets in January. Credit spreads were only marginally tighter, corporate issuance slowed, and prices of commodities including oil, natural gas, and gold all pulled back during the month. With the fiscal cliff resolution in the rear view mirror, market participants turned their attention to the sequestration, or budget cuts. Despite the usual political theater, the markets were priced for the budget cuts to take effect by month-end. On the last trading day, President Obama signed into law $1.2 billion over 10 years in fiscal austerity after Congress was unable to broker an alternative resolution. While we continue to expect only moderate economic growth, we do not believe that the particularly weak fourth quarter portends any meaningful risk of a new recession.
The U.S. macro picture maintained its slow growth posture and fourth quarter gross domestic product (GDP) was revised modestly higher from -0.1% to 0.1%. The components of the data still pointed to a decline in government expenditures and a drawdown on inventories, while consumer spending, residential investment, and capital expenditures all expanded. Other economic data showed that orders for capital goods rose month-over-month, annual vehicle sales climbed over 15 million units, and housing starts were higher as the residential housing market continued to be a clear bright spot in the recovery. The consumer has shown relatively strong resiliency and a desire to spend following several years of personal balance sheet deleveraging. It is worth noting, however, that the increase in the payroll tax coupled with a rise in gas prices have put pressure on lower income consumers.
U.S. Federal Reserve Chairman Ben Bernanke reaffirmed the central bank’s monetary policy stance and pledged to maintain its important bond buying program. This statement proved critical as recent minutes to the previous Federal Open Market Committee (FOMC) meeting signaled dissension among some of the Fed governors who questioned the continuation of the current quantitative easing program after 2013. The remarks provided a lift to risk assets.
Europe’s economic troubles have not gone away, and much of the continent remains mired in a recession. Average unemployment is just below 12%, but more than double this level in countries such as Spain and Greece. Recently failed elections in Italy have served as a reminder of the difficult path of austerity, and in the UK, Moody’s downgrade of the government’s debt to Aa from Aaa* further reduced the availability of high quality safe haven investments. Moody’s cited weak growth and rising debt levels as contributing factors to the British economy’s deterioration. Despite this all, we continue to see some evidence of countries taking important steps to curb their reliance on foreign credit and improve their current accounts. We maintain our view that the European Union will remain intact and not create a “left tail” event as both the political and economic costs would be far too expensive to absorb.
In China, which we would characterize as the third significant “center of risk” outside of the U.S. and Europe, manufacturing activity slipped and equities retreated as the government looked to balance growth and inflation risks. The rapid rise in residential housing prices has been of particular concern to officials, and recent discussions have taken place with respect to the enforcement of property curbs that would reign in this growth.
U.S. Treasury rates declined and the yield curve flattened in February. The benchmark 10-year note has traded in the 1.5% to 2.0% range since the Spring of 2012.
Treasury Yield Curve
Source: Bloomberg, 2/18/13. Past performance is no guarantee of future results.
The U.S. economy continues its slow path of recovery, and the current climate of moderate economic growth readily supports valuations in the credit markets. The strong demand for yield in the current low rate environment is another important factor, as is the fundamental health of the issuer base, which we believe is in the best shape we have seen in years. Important credit metrics such as balance sheet liquidity, leverage ratios, debt service costs, and access to capital appear attractive across issuers and industries. The U.S. economy has been very resilient to date, and market participants have become much less concerned with the macro-related volatility.
It is important to highlight in the current low interest rate environment that our central tendency is to overweight credit risk and underweight interest rate risk. For funds that permit the use of Treasury futures, we have held a shorter duration posture in the portfolio relative to the benchmark in order to dampen the funds sensitivity to a back-up in interest rates.