Market Sector Update
- The volatility in the Treasury market over the first quarter has given us a window into the type of volatility we could expect over the next couple of years.
- The Federal Reserve (Fed) has stated the desire to begin to normalize its interest rate policy. Unfortunately, the weak U.S. economy is not allowing them to begin to raise rates as quickly as they might like. The timing of the first fed funds rate hike has been moved to later this year, if not into next year.
- Economic weakness in most developed countries has led to a strong flight-toquality trade into the U.S. Treasury market. This weakness is showing signs of spreading to the U.S. economy.
- The strong flight-to-quality trade that the bond market has witnessed over the last several months should continue through the rest of 2015. As long as this trade remains intact, long duration Treasury yields could remain relatively low.
- Earlier this year we lengthened the duration of the funds we manage. We did this by increasing our exposure to longer-maturity Treasury bonds and reducing our overweight positions at the middle of the interest rate curve.
- The new normal appears to be significantly less net new issuance of mortgage-backed securities. As a result, mortgage spreads continue to be tight. Our mortgage holdings are structured to experience less extension risk during periods of rising interest rates.
- While the Fed still appears to be willing to keep rates low for a long time, they have indicated a growing desire to begin to normalize monetary policy. They have indicated the risk of higher inflation is less of a concern than the threat of renewed economic weakness.
- The market does not anticipate the Fed to begin raising the fed funds rate until late 2015. However, this is a very volatile and data dependent prediction. With the short end of the yield curve anchored by the low fed funds rate, we expect to see continued volatility in the middle and longer end of the curve.
- Even slight changes in the U.S. economic outlook can have significant short-term effects on longer duration securities.
- In the past, sustained bond bear markets have not been able to get underway until the Fed tightening cycle is imminent. We expect to keep our duration neutral to our benchmark over the next three months. We anticipate continued demand for spread product within the high-grade bond market. We are willing to take additional credit risk when we believe we are being compensated to do so.
The opinions expressed in this commentary are those of the Portfolio's managers and are current through March 31, 2015. The managers' views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. Past performance is no guarantee of future results.
Risk factors. As with any fund, the value of the Portfolio's shares will change, and you could lose money on your investment. An investment in the Portfolio is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the Portfolio may fall as interest rate rise. These and other risks are more fully described in the Portfolio's prospectus.
Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. For a prospectus, or if available, a summary prospectus, containing this and other information for the mutual funds offered by Waddell & Reed, call your financial advisor or visit us online at www.waddell.com. Please read the prospectus or summary prospectus carefully before investing.