Fixed Income Outlook in 5 Charts – A Flight to Quality as Global Conflict Intensifies
By Komson Silapachai, Partner, Research and Portfolio Management
1. Uncertainty is at its highest level since March 2020. The Russian-Ukrainian war has injected enormous uncertainty into global growth and the political outlook, resulting in a period of heightened volatility after the invasion from Ukraine on February 23 Interest rate volatility, as represented by the MOVE index, has been rising since the fourth quarter of 2021 and is now at the highest level since the Covid crisis in March 2020.
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2. The rate could remain lower than forecast. Fed prices have adjusted lower in response to the Russian invasion as interest rate markets now discount only six hikes through 2023, down from more than seven hikes previously (February 15, 2022 ). Given the rising political risk premium and unstable financial markets, rates could remain lower than expected until the March Fed meeting.
3. Growth is expected to slow in 2022. The Atlanta Fed’s GDP estimate for the start of the first quarter was close to 0% given early growth readings that are below expectations. A build-up in inventory in the second half of 2021, along with a decline in the trajectory of consumer spending, is contributing to what looks like a slowdown. A lack of budget spending in 2022 will force the private sector to make up the difference, which is unlikely. The consumer, who had accrued significant savings from stimulus and staying at home, spent much of it on the rebound. A savings rate at pre-Covid levels (as well as an increase in credit card debt) supports this notion.
4. Although rates have been revised, credit remains resilient. Corporate bond spreads continue to trade at near historic lows given the rate and equity repricing. A factor supporting US credit could be the influx of foreign investors looking for an attractive return without currency risk.
5. With the end of Fed QE, net supply could result in cheaper MBS. The Fed has purchased more than $1.2 trillion of agency MBS over the past two years, providing demand to meet higher MBS supply. Absent QE, asset managers will have to absorb an additional $500 billion of MBS supply this year, which could widen MBS spreads. This could present a buying opportunity once spreads adjust.
Source on all charts is Sage, Bloomberg.
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