SOUNDING LIKE A BROKEN RECORD
At the risk of sounding like a broken record, we remain stubbornly range bound as the market continues to find a lack of meaningful catalyst to move it from the low volatility environment that we have found ourselves in for the better part of the last four to five months. Not that there have not been opportunities to change its view, from both a higher and lower rates perspective. More recently, we had a spate of much stronger than expected domestic economic data and possible contagion concerns emanating from the Portuguese banking system. While these events and other market murmurs have pushed yields to trade between 2.5% and 2.65% over the past few weeks, we remain largely within the range that has been in place since mid-April. Ultimately, the Fed’s view has dictated market actions and, like good little soldiers, we are all following their orders. We ultimately found it comical to believe that Yellen would deviate from her highly crafted dovish message during this week’s Congressional testimony and unfortunately found our views correct, even though we secretly hoped we were wrong. So while economic data continues to point to a possible earlier “lift off date” for rate hikes, the message remains that rates will stay “extraordinarily low for an extended period of time”. The market has taken this message as gospel and we continue to have a flattening trade driven by underperformance at the short end and out performance at the long end. As the first chart below indicates, the two-year is the only maturity that has seen any significant volatility since the start of summer, with the rest of the curve mostly unchanged. So, while we have started to build in a mid-2015 rate increase, the futures markets continue to expect a much slower ramp period than even what the FOMC dots indicate, likely taking Yellen’s voice as a super vote. Given that Yellen has stated that the Fed is comfortable reacting to data rather than proactively anticipating inflation, we may find ourselves in this range for a little while longer. This also is ultimately a concern that the Fed will find itself behind the 8-ball in the hiking camp, an especially challenging position given the size of its balance sheet and the significantly reduced market liquidity.