Fixed Income Highlights
- "I drink your milkshake!" Daniel Day-Lewis’ most memorable final-scene line from There Will Be Blood (2007) provides a metaphor for directional drilling. Combine directional drilling with hydraulic fracturing and you get the U.S. natural gas and tight oil boom. That boom partly lies behind the collapse in oil prices, bringing with it the "blood" of collapsing energy-related investments. To wit, the energy sector in high yield stands down more than 10% since the end of June, mirroring its equity counterpart S&P500 Energy sector, down over 20%. For fixed income investors we highlight three key consequences: a consumption "tax cut" boost, a divergent impact on emerging markets of winners and losers and a tail risk to high yield.
- Return to the O.C. Nope, that is not a reference to a new Orange County reality TV show but to "Optimal Control," the Fed’s preferred tool for monetary policy making. A recent Fed staff paper suggests that the OC-prescribed path for interest rates argues for liftoff now. Why should any of this inside monetary policy baseball matter? Because the OC framework provided much of the intellectual justification behind the market’s belief in "low for longer." Count the "OC" indicating liftoff from zero rates, along with recent comments by NY Federal Reserve Bank President William Dudley and vice-Chair Stanley Fischer, as further evidence arguing for a faster liftoff from zero rates than is currently priced by short-term interest rates. December’s Federal Open Market Committee statement later this month will cap that view. Excising the "considerable period" language will set the market on course for a June liftoff from zero interest rates, making the shorter maturity segment of the bond market the most vulnerable to higher interest rates.
- How I Stopped Worrying and Learned to Love the Bond, Reviewed (our annual review of 2014’s My Favorite Themes and fixed income performance). Like so many years before (with the one exception of 2013), predictions of rising rates again flummoxed the "experts." Our view that "where you hold your duration matters as much as how much duration you hold" helped to mitigate that error as we emphasized longer maturities whose performance in 2014 topped all categories. A more tactical allocation "rebalancing credit and interest rate risks" also proved correct, as more variability in credit returns previews a more challenging environment for credit in 2015. Dollar strength undermined global fixed income performance (for dollar-based investors) as our call for a stronger dollar vs. foreign currencies was supported by the now prevalent viewpoint of "divergences." That latter theme features prominently in the outlook for 2015, a topic we’ll address in more detail in early January.