BNY Mellon Capital Market – Weekly Market Commentary

Three percent has become the new range for the 10-year in a post-taper environment. While tapering was easily the most anticipated event last year, the Fed’s pulling of the actual trigger continued to distort money flows. The adage “once fooled-twice shy” is possibly appropriate given the rise in rates over the past month, along with the return of possible dislocations to various emerging markets.  Whether these are/were moves promoted by low holiday liquidity, or money flows moving towards a post-taper equilibrium, we will find out in the coming weeks. From a fundamental perspective, or one where the Fed has signaled that tapering will end in 2014, but tightening will not commence for some time yet, the curve appears overly steep and rates relatively generous to other global curves. However, we continue to think that investor attention will naturally begin to consider an earlier tightening event (dare we contemplate late 2014) as Fed bond buying ends and the economy continues to outperform. Greater adoption of this view will most greatly influence the shape of the curve, which remains historically steep as the short end has remained relatively anchored. The recent underperformance of the three-year indicates that some of these thoughts may be making their way into prices.

In contrast, corporate and high yield finished the year at their tightest post-crisis levels. Cyclically low default rates and expected earnings growth should be supportive of current levels in our assessment, although we find it difficult to envision much in the way of additional gains given the strong moves over the past two-months. Earnings will potentially provide a positive catalyst for the financial sector next week, with S&P 4Q:13 y/y EPS growth expected in the six percent range. Lest we forget, tomorrow is the monthly employment report, with consensus in the +195k range and the whisper above +200k. Our guess is that we are due for a slight miss, although not enough to derail the improving economic thesis. We will also have a litany of economic releases next week, including retail sales, consumer confidence, inflation and housing.