Market Sector Update
- The U.S. Treasury market had a strong third quarter. Concerns over growth in China and declines in its equity market helped feed the Treasury rally.
- The final read on second quarter U.S. gross domestic product (GDP) growth was 3.9%. Economic growth for the third quarter is expected to come in about 1.5% to 2.0%. The unemployment rate fell two-tenths of a percent in the third quarter to 5.1%, very close to the Federal Reserve’s (Fed) definition of full employment. Several other key economic readings were also strong.
- In spite of the relatively good domestic economy, the Fed chose not to raise the federal funds rate at its September meeting, stating concerns about China and the financial market instability for its inaction.
- Investment-grade credit spreads continued to widen in the quarter. Even with wider spreads, corporations were still eager to issue bonds at relatively low absolute yields. They have continued to issue this debt to finance the big wave of mergers and acquisitions we have seen this year. They are also using debt to increase dividends and fund stock repurchases.
- In the second quarter we shortened duration in anticipation of a rate hike in September. When we didn’t get the rate hike that many in the market were expecting, we lengthened duration from approximately 85% of the benchmark to approximately 90-95% of the benchmark.
- We lengthened duration using U.S. Treasuries and increased our overall holdings in U.S. Treasury securities. We remain underweight the long end of the curve, as the potential risks of having an over-exposure to long duration are large..
- We believe we are closer to the end of the credit cycle than the beginning and will be looking for additional opportunities to reduce our credit exposure as they become available. This will be an ongoing project lasting several quarters and perhaps years.
- The yield curve on mortgage-backed securities keeps us from having a greater exposure there right now. We do look for opportunities, however, to add mortgage-backed securities which we believe to not present much extension risk when rates rise.
- It’s not clear whether the Fed will feel confident enough to raise rates in 2015. If U.S. economic data remains stable and the rest of the world doesn’t worsen, then a December rate increase is quite possible. The Fed has indicated they expect to raise rates very gradually once they do start the process.
- The Fed has said that the lack of inflation in the United States isn’t a huge problem, as the primary forces keeping it low — falling energy and commodity prices — are transitory.
- We believe that investment-grade credit issuance will probably continue the record pace seen so far this year. Spreads could continue to widen as companies continue to add leverage to their balance sheets.
- The volatility seen so far in 2015 has shown no signs of waning. Each good economic data point brings us closer to a rate hike, while each negative surprise puts Fed action on hold. Both positive and negative news have a significant impact on the price action in the U.S. Treasury market.
The opinions expressed in this commentary are those of the Portfolio's managers and are current through Sept. 30, 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.
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