Anfield Fixed Income Update: March 2021
In the US Federal Reserve’s most recent Federal Open Market Committee (FOMC) address on March 17th, Chairman Jerome Powell maintained a message of consistency—or what Morgan Stanley economists called a “triple-down” on dovish guidance— on the path forward for policy and the Fed’s reaction to the recent rise in US Treasury yields. The highly watched dot plot showed the 2023 median dot unchanged at 0%, a signal the Fed fully intends to follow through on its Average Inflation Targeting (AIT) and maximum employment reaction function.
Chair Powell went on to highlight the Fed’s forward-looking expectations, which include ending the year with strong economic growth and equally strong inflation as measured through the core PCE deflator. Specifically, the Fed is projecting a 2.2% Q4 2021 YoY rate for this metric, which is currently above the 1.9% Bloomberg consensus rate. This represents a sharp increase from the Fed’s previous December projection in which they forecasted ending 2021 with a core PCE deflator growth rate of 1.8%. In the longer run, the Fed also upgraded its projection on inflation with a core PCE deflator growth rate of 2.1% for 2023, an increase of 0.1% from their December projection.
In terms of possible future actions that could be taken by the Fed, while we are observant on possible rate increases and the start of tapering, we do not anticipate any major actions until strong economic conditions are realized. We also believe that any movement on the Fed’s part in relation to inflation would be from a sustained and persistent environment of 2%+ (as opposed to hitting the number followed by Fed action). In the press conference, Powell reaffirmed the intention to provide significant advance notice on a taper start date, which many believe to be the Fed’s next move in a gradual tightening sequence. While the team believes there is a minimal chance of rates going lower from here to year-end, we do see the potential for further steepening and accordingly are pushing our year-end interest rate outlook to a lower bound range on the 10-year of 1.50-1.75%, with the potential to hit 2.00% by year-end.
Overall, our fixed income strategies have been positioned for the rising rate environment and have benefited over the past couple of months from these sharp moves upward. Our Universal strategies have historically been in low(er) duration postures while our Dynamic strategy saw a reduction in long duration holdings at the beginning of the year. We would anticipate that the strategies would continue to benefit should the current conditions persist.
Sources: CreditSights, Morgan Stanley
CURRENT FIXED INCOME POSITIONING
Sources: Morningstar, Bloomberg, Manager as of February 28, 2021
Universal Fixed Income Strategies: Benchmark agnostic and line-item bond security portfolios looking to highlight our best ideas in bond space
Dynamic Bond strategy: Benchmark aware to the Bloomberg Barclay’s Aggregate Index and is a top-down macro-focused ETF of ETFs.
"Anfield Affection Gauges:"
What fixed income sectors & exposures do we like, and what do we dislike?
Long Duration Gov't Bonds LQC Mortgages Structured Products/CLO's HQC
Non-US FI LQC Government Bonds Mortgages HQC
LQC = Lower Quality Credit HQC = Higher Quality Credit
Current Fixed Income Positioning Definitions:
Duration represents the current value for each of the funds and indices noted
Curve represents where each of the funds and indices are positioned on the yield curve
Government represents the percentage allocated to Government bonds within the funds and indices
Credit represents the percentage allocated to Investment Grade and High Yield Credit within the funds and indices
MBS represents the percentage allocated to Mortgage-Backed Securities within the funds and indices
Yield (YTM) represents the Yield to Maturity of the funds and indices
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