Podcast: February 2010 Market Recap

SEI Global Fixed Income Management manages fixed-income strategies for SEI’s Managed Account Program (MAP) and Integrated Managed Account Program (IMAP).

Hello, my name is Sean Simko. I am Managing Director of SEI Global Fixed Income Management. Today’s discussion is a recap of the market activity and performance for the month of February.

Changes within the economic climate continued to affect the fixed-income markets. Pockets of weakness still exist in the labor market, housing market and consumption figures, unsettling many market participants. Although these negative trends are not new, there was hope that they would show consistent signs of improvement. Lack of clarity surrounding sovereign debt issues has added to the uncertainty. Greece remained in the headlines as policymakers proposed different ideas about how to correct its current fiscal dilemma, but the problem runs much deeper. While direct exposure to Greece is limited for most investors, the indirect exposure through banks and financial institutions could sneak up and become problematic.

All said, our proprietary fixed-income sentiment model continues to show signs of an improving outlook. While economic data reflects our view, it does not capture the overall tone of the market, which is important due to the impact it has on investors’ emotions, and ultimately, their actions. The downside is that emotion has the tendency to create volatility and wild swings. Uncertainty is setting the tone, as market participants continue to question (as we do) the sustainability of economic growth. We need to see domestic growth fueled by capital and consumer demand, instead of by inventory rebuilding and government stimulus.

The Barclays Capital Aggregate Index continued its positive run, returning 0.37% for February. The numbers seem to show that there was not a lot of activity, but the day-to-day swings tell another story.

The Federal Open Market Committee minutes that were released carried a modestly hawkish tone but were trumped by the Federal Reserve (Fed) lifting the discount rate. The Fed hiked the discount rate by 25 basis points on Thursday, from 50 basis points to 75 basis points, making it more costly for banks to borrow from the central bank and possibly signaling the beginning of the end of easy money. This move can be looked at as a purely technical change. While it was the first increase in the discount rate since 2006, the change must be kept in perspective. At the end of January, there was approximately $14.7 billion on loan through the central bank, a drop in the bucket compared to the trillion dollars the Fed has pumped into the system since the crisis escalated in 2008. The economy is getting stronger; however, bumps still remain in the road. By increasing the discount rate, the Fed has removed an emergency resource created to promote market and economic stability. Although the move came sooner than some expected, and caught some market participants off guard, it has been highly telegraphed with increased rhetoric over the past week. The Fed went out of its way to reiterate that this move does not have any impact on monetary policy, reiterating that the federal funds rate would remain low for an “extended period.”

Our expectation remains that the Fed will keep rates unchanged until the fourth quarter, if not the first quarter of 2011. There will be an increased amount of “Fedspeak” over the upcoming months, addressing specifics on changing the statement language and the timing of monetary-policy tightening. We will be monitoring this rhetoric closely to uncover any hidden clues or indications that may change our view. 

Treasuries traded in a tight range, ending the month mostly unchanged. The market was volatile, bouncing from data point to data point and juggling sovereign debt concerns and supply pressures. The five-year part of the curve led the rally, with yields pushing lower by 7 basis points to 2.30%. The underperformer was the 30-year, rallying half a basis point to 4.55%. The Barclays Capital U.S. Treasury Index returned 0.40% for the month, bringing its year-to-date return to 1.98%. The 2- to 10-year curve moved in parallel fashion, finishing the month at 280 basis points. Uncertainty about the timing of monetary tightening plagued the front end, and when all was said and done, the yield curve remained anchored in alignment with the current zero-interest-rate policy.

The Treasury Inflation-Protected Securities (TIPS) market underperformed its nominal counterpart for the month. The Barclays U.S. TIPS Index returned -1.16% for the month but kept a positive return of 40 basis points year to date. Inflation data was not strong enough to increase demand in the TIPS market, even as oil hit $80.00 per barrel during the last week of the month. Commodities continue to push higher, but for now, the move is more of a currency play than a signal of inflation concerns.

The investment-grade credit market lacked clear direction, as investor sentiment seemed torn between macroeconomic risk factors and improving credit fundamentals. Crosscurrents of risk brought about by European sovereign credit concerns and U.S. political risk weighed on spreads, while the strength demonstrated through the fourth-quarter earnings season provided support. Ultimately, aggregate investment-grade option-adjusted spreads, as measured by the Barclays Capital Credit Index, widened 2 basis points on the month but outperformed Treasuries. Within the index, broad-sector Industrials led the way, while broad-sector Financials and Utilities underperformed.

New issuance fell markedly this month to $57.7 billion from $98.1 billion. We expect the calendar to pick up in March after the lackluster showing in February. The improving tone of the global markets should provide a boost to issuance that was missing last month.

Municipal market activity decreased marginally, as non-institutional investors remained quiet due to record low interest rates. Municipal bonds outperformed their taxable counterparts, as issuance for February moved ahead of where it was last year. Investors continued to move out of low-yielding money market and short-term strategies in a search for higher yields. The Barclays Capital Municipal Index returned 0.97% for the month and 1.50% year to date. As a result, yields in February rallied 16 basis points at the ten-year point of the AAA curve to finish at 3.08%. The 30-year point moved lower by 3 basis points to finish at 4.43%. High-grade municipals as a percentage of Treasuries ended the month cheaper than they were at the start of the month. The 10-year AAA general-obligation debt percentage to Treasuries started the month around 90%, which was above the historical average. At month end, though, this ratio was at 85%, moving closer in line with historical averages. Even with the move lower, the yield curve remained very steep and ended the month close to 400 basis points. The steepness was driven by the front end, as investors searched for additional yield outside money market strategies. Municipal issuance totaled $25.1 billion for the month, with tax-exempt issuance making up the lion’s share. Tax-exempt issuance totaled $17.1 billion, with taxable issuance making up the remaining $8 billion.

Concerns about the potential bankruptcy of Harrisburg, Pennsylvania’s state capital, ignited default concerns and showed that other regions of the country are not immune to the same troubles that California currently faces. Budgetary issues plague most states due to high unemployment and poor housing market conditions. Until states and municipalities become more fiscally responsible, conditions will likely worsen, putting pressure on spreads and creating uncertainty and volatility.

We expect Treasury yields to remain range-bound in the near term with a bias to move higher from current levels. We will be watching auctions and Treasury International Capital flows—foreign capital being invested in Treasuries—for clues on demand. Municipal market participants will also be on guard, as we have now entered the period through mid-April that has historically provided negative price action within the sector. We are cautiously optimistic on the economy and markets, but we remain defensive due to continued questions about the sustainability of the economic recovery.

If you have any questions regarding this commentary or questions about the markets, please contact your SEI representative.

Thank you.