Yields are generally lower over the past week, as flaring geopolitical concerns gave treasuries a flight to quality bid. The list of these concerns is long, including Syria, Egypt, the emerging markets, and a weak set of economic data points. While by no means insignificant, we find many of these current concerns as potentially having only limited impact on a market that will once again face its tapering demons. Having said that, yields were almost 20bps tighter before today’s sell-off and the curve has bull-flattened. We had thought that yields had priced in a worst case September taper with an aggressive reduction schedule when rates were last in the 2.8% range. We have included data that indicates the Fed funds to 10-year curve should get much steeper without an actual Fed tightening or a rapid rise in inflation. This, therefore, calls for rates to continue to consolidate in the 2.7% – 2.8% range. While a significant deterioration of geopolitical events has the potential to push rates well below the 2.7% range, we are not in that camp at the moment. Investment grade spreads have remained fairly stable during the recent periods of treasury gyration, while HY has underperformed, indicative of its greater sensitivity to fund flows, which remain anemic. Overall, fixed income performance will be negative again in August, with YTD returns also in negative territory for most bond classes. While EM underperformance was expected, we highlight the weak performance in the muni market, which is lagging due to higher rates and idiosyncratic credit concerns. We have also included a review of the issues that prompted Moody’s to place all the SIFI banks on review, with downgrades for certain classes of banks and finance bonds likely by the end of the year. Read the full commentary now.
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