We, and practically everyone else that had expected a tapering this year, have capitulated following the disappointing employment report this week. Despite the delay of the report, we feel that it can be viewed as an accurate reflection of the job market, with the usual caveats that it is a volatile time series that is subject to large revisions. The capitulation on tapering being a March and possibly June 2014 event has led to a sharp rally in rates that has retraced one third of the widening we experienced since hitting the low of the year last May. Volatilities have subsequently collapsed since the start of the month, and are now below what we had thought was the low volatility print last April. As such, we are faced with the need to determine where in the QE infinity retracement trade we think the market will settle. Rates appear to have more momentum to move lower, something our PRM models support in the short and intermediate term. Corporate credit is trending near the year’s low spreads, but has been unable to break through the +130 Maginot line on four prior attempts over the past two-years. HY has also retraced a large portion of this summer’s widening, standing at 5.75%, but still 80 bps above the low yield of the year. We have always thought that the Fed’s tapering discussion was as much about controlling risk bubbles and efficacy as it has been about improving data. A HY market below 5% fits into those asset bubble concerns, so we would not expect a retest of those lows, but can still see additional tightening. We do think that the Fed will be tested if rates continue dropping, as the bubble and efficacy issues were legitimate Fed concerns this spring. With tapering expectations pushed into next years Fed, it is worth noting that there is likely to be a more hawkish committee composition. In addition to four rotating district presidents, there are three vacancies that need to be filled. While the Fed Chairperson dominates the tone, presuming the continuation of the current dovish tone warrants at least a review. Read the full commentary now.
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