Leader Month in Review - May 2015
May was a rough month for most fixed income sectors, with only High Yield managing to post a positive return (top table). Treasury yields were mostly flat, except for the long-end, where the 30 Year yield increased 6 bps (bottom table). However, it was not without heightened volatility (chart 1, the MOVE Index is like the VIX but for Treasuries).
Spreads on MBS and Investment Grade Credit widened modestly while High Yield spreads were flat. Year-to-date, the 50 bps tightening in High Yield spreads has led to a 3.07% excess return over Treasuries. Similarly, High Yield has outperformed higher quality credit this year, as Investment Grade spreads are flat (chart 2, top panel). Except for January, Investment Grade credit issuance has been outpacing 2014, a record year for new issuance (chart 2, bottom panel). This has undoubtedly been weighing on spreads as the two largest issuance months, March and May, saw spread widening.
With the unemployment rate at 5.4%, the unemployment gap is now closed since the “natural” rate of unemployment is estimated at 5.0-5.4%. In fact, wage growth has been ticking up, which is consistent historically with how wages perform when the economy closes the unemployment gap (shaded grey areas, chart 3)
This has translated into inflation moving towards the Fed’s 2% target with the most recent CPI reading of 1.8% YoY. Shorter time periods show even more strength, with a 3-month annualized rate of 2.6%.
The latest release of FOMC Meeting Minutes highlighted the Fed’s desire to begin interest rate normalization this year. The 10 year Treasury yield has already started pricing in a rate hike this year, having bottomed in February. Over the last three interest rate cycles, 10 Year yields begin to price interest rate raises on average 5 months ahead of time (see chart 4).
Economic Data Releases: