A sell-off in rates accelerated into month-end as the yield curve steepened by 25 bps, as measured by the 2-30 spread. U.S. Treasuries underperformed all other sectors except for Investment Grade Credit, which returned -0.70%. However, it was the interest rate component of Investment Grade Credit that led to poor performance since spreads actually tightened by 2 bps during the month. High Yield spreads also tightened during the month, leading to the 1.21% return. Year-to-date, High Yield has outperformed the core fixed income sectors by 252 bps.
The U.S. economy had a dreadful Q1 – cold weather and the LA port shutdown led to a 0.2% GDP print, coming in much lower than analysts’ expectations but in-line with the Atlanta Fed’s GDPNow forecast (chart 1) However, similar to last year, we expect the economy to rebound back to trend. One reason is the recent hook up in core inflation measures (chart 2) as the drag of a stronger dollar and weak oil prices subsides.
FOMC minutes highlighted the growing debate within the Fed over the timing of the first interest rate hike. We have stated previously that the pace of rate hikes is more important than the initial lift-off date and the internal debate is a return to normal central bank operation and normalized monetary policy. As we grow closer to the lift-off date, we expect Treasury market volatility to pick-up, which has been occurring (chart 3). The MOVE Index, like the VIX Index but for Treasuries, is at an elevated level from last year and closer to the levels from the “taper tantrum” in 2013. We think it’s not out of the question to see a similar sell-off in Treasuries this year when the first rate hike is announced.
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