The tortoise and the hare
By Benjamin Streed, CFA
January 11, 2016
Since the Fedâs hike on December 16th, Treasury yields across the curve are lower, with some seeing significant declines of 10 basis points or more. Whatâs to blame? Some combination of volatile equity markets, weak oil prices, Middle East tensions, weak/false economic reporting and bans on short selling being lifted in China pushed equity markets lower across the globe. Many people were waiting for history to be made post-Fed, and the markets obliged, albeit in an uncharacteristic way. The Wall Street Journal called this the worst opening for stocks in history with US stocks losing $1.26 trillion in value last week with major indices down 6% or more. Meanwhile, to the surprise of some the bond market is chugging along and posting some decent year-to-date returns. The broad Citi Treasury index is up 78bp so far with longer-dated 7-, 10- and 30-year benchmark securities posting gains over 1% at 1.20%, 1.30% and 1.88% respectively. Thanks to the global âflight to qualityâ investment grade corporate credit is positive across the board with higher quality AA-rated paper slightly outperforming A and BBB-rated peers, with each group returning >70bp in the first week of trading.
As a result, market participants are now beginning to wonder if the Fedâs timing was off and are now anxiously debating what the committee will do next. As before, the committee remains data dependent and will consider global circumstances in any further changes in monetary policy. For example, Fed Vice Chairman Stanley Fischer noted that Chinaâs slowing economy is clouding the outlook for economic growth making it very difficult to predict the path of monetary policy. Although Fed officials see the possibility for four quarter-point hikes in 2016 the markets are betting otherwise: Fed funds futures are now implying that any hike before June is less than a 50/50 shot. For comparison, on New Yearâs Day the probability of a hike was >50% for a March hike.
This abrupt âabout-faceâ has many wondering what is in store for 2016 and whether the first week of trading will bear any indication of what will occur in the next twelve months. If anything, this is a helpful reminder why bonds matter to investment portfolios no matter what the prevailing interest rate environment looks like. Whether rates are high or low, the Fed is hiking or cutting rates, bonds will always act as a downside hedge or volatility cushion for those owning any type of risk asset, including equities. For much of 2015 and now YTD 2016, the relatively unloved tortoise (bonds) is outperforming the hare (equities). Keep your eyes on the tortoise, it might surprise you this year.
