The general tone in risk markets improved notably in the first quarter of 2019, but cracks in this bullishness began to surface toward the end of March. A sharp decline in Treasury yields began immediately following the FOMC meeting on March 20, which was more dovish than expected, and weaker global economic data and geopolitical concerns further fueled an increase in Treasury prices and implied rate volatility in the ensuing days. Additionally, the 3-month/10-year Treasury yield spread inverted for the first time since mid-2007.
On the data front, preliminary readings on March manufacturing PMI data from Europe were much weaker than expected, particularly for Germany, and U.S. data for both services and manufacturing came in below expectations. The U.S. manufacturing reading was the lowest since June 2017, and the March decline in the service sector survey erased much of the gains from the prior two months. Geopolitical risks from Brexit have also contributed to a bullish tone in Treasuries, creating a snowball effect.
The sharp rally in Treasuries raised questions regarding the health of the U.S./global economy and future Fed policy.
The March FOMC meeting was more dovish than expected, with no projected rate hikes in 2019 according to the median participant forecast.
Yield curve inversion became a greater area of focus as March progressed, with a favored Fed metric inverting for the first time in the current cycle.
The move in Treasuries was not mirrored in risk markets. U.S. equities were slightly higher amid the bond rally and credit spreads were only modestly wider (investment-grade credit spreads tightened). Nevertheless, a sharp move in government bond yields for less than obvious reasons raises questions in broad markets of whether bond investors are pricing for a larger paradigm shift (i.e., a canary in the coalmine). While the front-end of the yield curve (2yr-5yr) has been inverted for much of the last four months, the 3-month/10-year inversion sparked fresh concerns of what the move may be signaling. Most market participants are well aware of the correlation between curve inversion and recession risks and fed funds futures and OIS markets are now pricing two 25 basis point rate cuts by the end of 2020. From a monetary policy perspective, recent discussions centering on “inflation targeting” have further fueled speculation that a rate cut may be the next move by the Fed, despite recent FOMC forecasts. The concept of average inflation targeting involves allowing inflation to run “hot” above the target rate (2%) to offset periods of below-target inflation. In other words, would the Fed reverse one or more rate hikes in order to stimulate above-target inflation?
This market overview is provided by ALM First Financial Advisors, LLC, the investment advisor for Trust for Credit Unions. Read more from ALM First about the latest economic data releases and overall market trends at Trustcu.com.
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