Economic and market perspective
U.S. economic data surprised to the upside in December with strong employment and growth results and the Fed remained on hold as expected. Progress on tariffs and U.K. election results lowered geopolitical noise for the time being. These developments led to continued improvement in risk sentiment.
On December 13, two days before additional tariffs were to be implemented, the U.S. and China announced they had agreed on phase one of the long sought after trade deal. The U.S. agreed not to implement the December 15th tariffs and to cut the tariff rate in half on the September tariffs, but prior tariffs remain in place subject to further negotiations. China agreed not to implement the scheduled retaliatory tariffs, increase imports from the U.S. by $200 billion over the next two years and put better protections in place for U.S. intellectual property. President Trump said the phase one deal will be signed January 15th at the White House.
The Conservative Party won U.K. elections decisively in mid-December. Boris Johnson, the leader of the party, campaigned on a promise to “Get Brexit Done.“ Subsequent to the election, parliament approved Johnson’s Withdrawal Agreement – assuming it passes remaining steps in the U.K., the law will take effect in January. The European Parliament will also vote on the U.K.’s withdrawal. If all proceeds as planned, the U.K. is set to exit the European Union on or before January 31, 2020. An E.U. summit will then begin in February to negotiate new trade arrangements between the U.K. and the E.U.
Eurozone manufacturing PMI fell to 46.3, the 11th consecutive month below 50 (below the 50 level indicating contraction); composite Eurozone PMI showed expansion with a level of 50.6. U.S. ISM Manufacturing Index declined to 48.1 for November from 48.3 the prior month and below market expectations of 49.4. November was the fourth consecutive month showing contraction. By contrast, Chinese official manufacturers PMI was mildly expansionary at 50.2, exceeding market expectations. After a period of contraction, December was the second month in a row with modest expansion.
The Federal Open Market Committee left the Fed Funds rate unchanged at its December 10-11th meeting, in line with market expectations. In its statement, the Fed emphasized that “monetary policy is appropriate to support sustained expansion of economic activity, strong labor market conditions and inflation near the Committee’s symmetric 2% objective.” The updated ‘dot plot’ showed a downward move in the expectations of Fed members. In the September dot plot, nine dots reflected one or more rate hikes in 2020; in the most recent plot, only four dots projected one hike in 2020. The median expectations of future Fed Funds Rates also came down to 1.6% 2020 (from 1.9%), 1.9% in 2021 (from 2.1%) and 2.1% in 2022 (from 2.4%), though the long run estimate was unchanged at 2.5%. As of the end of December, the market is not pricing in a greater than 50% chance of any additional Fed actions in any of the next twelve months.
Outlook and conclusions
In our view, the fourth quarter was a welcome respite in the otherwise near linear downward trend in rates during 2019. After the first three quarters of 2019 when declining rates drove fixed income returns, in the fourth quarter rates moved moderately higher, but still delivered positive returns on the strength of non-governmental sectors. Progress on longtime geopolitical hotspots – Brexit & U.S./China trade – at the same time U.S. economic data surprised to the upside led to this adjustment higher in rates and strong performance from spread sectors. The fourth quarter highlights the difference between the environment entering 2020 versus a year ago. Last year, tightening monetary policy, slowing growth concerns and continued trade tensions created market volatility, but also wider spreads; though rates declined in the fourth quarter of 2018, they remained elevated versus today’s levels. At the beginning of 2020, loosening monetary policy and easing geopolitical tensions have created a more stable market environment with strong recent performance. The challenge emanating from this recent performance is that while credit could recently be described as fairly valued given the supportive environment, further tightening of spreads has made these valuations more tenuous. With more positive news now factored into valuations, markets have become more susceptible to disappointment. Spreads can stay in the current range for some time and this may be the most likely outcome. Indeed there is not an obvious near-term catalyst to reverse the tightening, but we view the risk of widening as asymmetric to the benefit of further tightening. As such, we remain cautious in terms of portfolio positioning regarding non-governmental exposure, but more comfortable with duration exposure. Even with these valuations, U.S. fixed income remains attractive in a global context; as the search for yield continues, U.S. fixed income offers a relatively benign venue for global investors to achieve higher yields.
Originally Posted on January 2, 2020 – January 2020 Fixed Income Market Update
This is not intended to serve as a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. Information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. This publication is prepared for general information only. This material does not constitute investment advice and is not intended as an endorsement of any specific investment. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investment involves risk. Market conditions and trends will fluctuate. The value of an investment as well as income associated with investments may rise or fall. Accordingly, investors may receive back less than originally invested. Investments cannot be made in an index. Past performance is not necessarily a guide to future performance.
Disclosure: BMO Global Asset Management
This website is for informational purposes only and is not intended to provide a complete description of BMO Global Asset Management’s products or services. Past performance is not indicative of future results. It should not be construed as investment advice or relied upon in making an investment decision. Information on this website does not constitute an offer for products or services, or a solicitation of an offer in any jurisdiction in which such solicitation or offer would be unlawful. Products and services can only be offered by appropriate representatives of the respective manager. Notice to residents of the United Kingdom: For the avoidance of any doubt, the information on this website does not constitute an offer for products or services to persons in the United Kingdom.
BMO Asset Management Corp. is the investment adviser to the BMO Funds. BMO Funds are distributed by Foreside Financial Services, LLC. Member FINRA/SIPC. FINRA’s BrokerCheck.
All investments involve risk, including the loss of principal.
Foreign investing involves special risks due to factors such as increased volatility, currency fluctuation and political uncertainties.
Investors should carefully consider the investment objectives, risks, charges and expenses of the BMO Funds. This and other important information is contained in the prospectuses and/or summary prospectuses, which can be obtained by calling 1-800-236-3863. Please read carefully before investing.
BMO Global Asset Management is the brand name for various affiliated entities of BMO Financial Group that provide investment management and trust and custody services. Certain of the products and services offered under the brand name BMO Global Asset Management are designed specifically for various categories of investors in a number of different countries and regions and may not be available to all investors. Products and services are only offered to such investors in those countries and regions in accordance with applicable laws and regulations. BMO Financial Group is a service mark of Bank of Montreal (BMO).
BMO Asset Management U.S. consists of BMO Asset Management Corp., BMO Asset Management (Canada)® includes BMO Asset Management Inc.
BMO Taft-Hartley Services and BMO Trust and Custody Services are a part of BMO Global Asset Management and a division of BMO Harris Bank N.A., offering products and services through various affiliated entities of BMO Financial Group.
Investment advisory services in the United States are provided by BMO Asset Management Corp., BMO Asset Management Limited, LGM Investments Limited, BMO Global Asset Management (Asia) Limited, Pyrford International Ltd and Taplin, Canida & Habacht, LLC.
Investment advisory services in Canada are provided by BMO Asset Management Inc., BMO Asset Management Corp., LGM Investments Limited, BMO Global Asset Management (Asia) Limited and Pyrford International Ltd.
Financial promotions in the United Kingdom are provided by LGM Investments Limited, Pyrford International Ltd, and BMO Asset Management Limited. LGM Investments Limited, Pyrford International Ltd, and BMO Asset Management Limited are authorized and regulated by the Financial Conduct Authority in the United Kingdom.
Asset management services in Hong Kong are provided by BMO Global Asset Management (Asia) Limited, licensed by the Securities and Futures Commission to conduct regulated activity Type 9 – asset management under the Securities and Futures Ordinance.
Investment products are: Not a Deposit — Not FDIC Insured — No Bank Guarantee — May Lose Value.
Copyright © 2020. BMO Financial Corp. All Rights Reserved.
TM/® Trade-marks/registered trade-marks of Bank of Montreal, used under license.
Disclosure: Interactive Brokers
Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from BMO Global Asset Management and is being posted with permission from BMO Global Asset Management. The views expressed in this material are solely those of the author and/or BMO Global Asset Management and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.