Headwinds Are Blowing, But the Ship Sails Onward Total Return Market Outlook

2019 proved to be a very strong year for almost all financial assets, as equities and bonds rallied in tandem. The Federal Reserve (the Fed) was compelled to play defense against a weaker global economy (particularly in Europe) and continued uncertainty related to the trade dispute between the U.S. and China. Three eases in the federal funds target rate (totaling 75 basis points) coupled with significant narrowing of investment grade corporate spreads helped propel the Bloomberg Barclays U.S. Aggregate Bond Index to an 8.72% return for 2019, its best since 2002.

For much of the first three quarters of the year, investors warily eyed the yield curve inversion as a precursor to a recession. However, the combination of three rate cuts (lowering shorter maturity yields) and some improvement in the outlook for U.S.-China trade and the Euro-area economy steepened the Treasury curve, primarily through a rise in longer-maturity yields. When the dust settled, the option-adjusted spread (OAS) of the corporate sector closed at 93 basis points, just 10 basis points away from the tightest levels seen since the financial crisis. The table below summarizes some of the key changes in rates and spreads during the course of 2019.





Fed Funds Target Rate




Corporate Option-Adjusted Spread




MBS Option-Adjusted Spread




2-Year Treasury Yield




5-Year Treasury Yield




10-Year Treasury Yield




30-Year Treasury Yield




MOVE (Volatility) Index




In our view, one of the main factors driving the market’s relentless pursuit of risk is how the Fed has portrayed its path forward for rates. It should be noted that the effective federal funds rate is actually 85 basis points lower year-over-year (down from 2.40% to 1.55%) as its target is approaching the floor of its range, whereas a year prior it traded closer to the cap – quietly adding another half ease in the process. Furthermore, we view the Fed as on hold for most of 2020. The hurdle to hike rates requires inflation to print persistently above 2%, which would take time to materialize. Conversely, we would need to see dramatic deterioration in the domestic economy to see the Fed lower rates from here. In other words – with risks balanced and inertia being a difficult force to overcome, the Fed is on hold at what we believe to be a relatively accommodative level. This should limit short-term rate volatility and perceived risks around Fed policy and will allow risk assets to continue to outperform.