Fixed-Income Purgatory

There is no better way to describe the current fixed-income environment than “fixed-income purgatory.” The dizzying environment has made every day feel as if it were Groundhog Day. The market opens and trades one direction before reversing course mid-day. The relentless news about global dislocations has created a range-bound environment across multiple asset classes and across the yield curve. Immunity is not an option, as the front-end money market instruments, credit sector and the municipal sector have all felt the pain.

The current levels of the Treasury market are hard to believe. Treasury rates are abnormally low, with the rate of the 30-year below 4%, the 10-year hovering around 3%, the five-year below 2% and the two-year just above 0.5% at a paltry 60 basis points. These levels are representative of the levels of pure panic that investors had to digest in 2008 and 2009 when the economy and banking systems were on the verge of complete meltdown. We know that the tone of both the economy and markets feels light-years ahead of those crisis levels.

You would think at this stage in a recovery (and yes, we are in a recovery), we would see Treasury yields at least 50 to 100 basis points higher than where they stand today. But no, the bond bears tried to push yields higher in the early part of the year only to be met with significant headwinds. These headwinds easily squashed the prospects of future growth and the potential threat of inflation—two factors that helped drive yields higher earlier in the year. The continuation of global sovereign debt concerns and the weaknesses in Europe and the European banking system were no match for hopes and dreams of higher yields and continued tightening of spread products. Add to this the lingering concern of a double-dip recession in the U.S. economy, and you can see why it feels like we are in a maelstrom, circling and circling but not going anywhere.

All hope should not be lost. The Federal Open Market Committee and other global central banks remain very accommodative in their efforts to help kick-start the global economy. Although economic growth has shown signs of slowing, indicators still point to growth. It should be clear at this point in time that two scenarios we did not buy into—the “V” shape recovery and the double-dip recession projections—should be thrown out the window. We feel that the path of economic growth will be positive but will resemble a flat line over the near term.

The turmoil in the European banking sector has been a thorn in the market’s side. Hopefully, results of the European banking stress test will be positive, which should calm investors and the market the way the U.S. stress tests did last year. Once accomplished, if the results are positive and the dark clouds over this sector and region are lifted, we would hope to see positive traction within the corporate and other spread sectors. The lack of desire to own Treasury securities at such low yield levels would help this move. Ideally, the flight-to-quality trade will reverse its course back into riskier assets in a move similar to what we saw earlier in the year.

If we combine a positive tone from abroad with firmer U.S. economic data, the backdrop should make for a healthier environment. Economic data continues to point to growth, albeit at a slower pace. This is expected due to the depth of the recent recession. Think of the scenario as “two steps forward and one step back.” Let’s just hope the step back that we are currently taking is a short one that doesn’t linger for multiple quarters.

As one would expect, the consumer is a key driver for continued growth. The only way consumers will remain in spending mode is if they feel comfortable with the employment picture. An unemployment rate of 9.5% does not provide that comfort. While it will take some time to accomplish, as the unemployment rate drops, consumers should feel more confident. When they do, their spending will help to propel the U.S. economy forward.

The global turmoil that has taken years to develop will take time to work its way out of the system. After the headwinds abate, we expect to see a much healthier, calmer and normally functioning market. Until then, investors will continue to look for opportunities while dodging the land mines in fixed-income purgatory.
SEI Global Fixed Income Management manages fixed-income strategies for SEI’s Managed Account Program (MAP) and Integrated Managed Account Program (IMAP).

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice. This information is for educational purposes only.

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SEI Global Fixed Income Management is a unit of SEI Investments Management Corporation which serves as the investment advisor.