Total Return Outlook: Take a Hike

Take a Hike

After a strong first quarter, the investment grade bond market treaded water in the second quarter. Treasury yields rose as there was some contagion following the bank failures in the first quarter as well as weakness in commercial real estate. This could become a problem for smaller regional banks, who also suffered most in the first quarter, as they tend to have relatively large exposures to commercial real estate. As they say, more news at 11.

The Federal Reserve continues down its path of steadying the ship in a sea of volatility that it largely created for itself. So far, so good – in recent weeks risk appetite has improved (outside of commercial real estate), lending to a narrative that any slowdown the economy may face will be relatively mild – if it happens at all. Corporate spreads ended June near their tightest levels of the year, with enviable equity performance to match. Mortgage-backed securities (MBS) have also improved as volatility has declined, though they remain vulnerable to a rise in rates as evidenced in May, when nominal spreads reached their widest levels in over a decade.

Against this backdrop, the Fed says it expects to raise rates at each of its next two meetings (for a total of 50 basis points). Recent -data substantiate the resilience of the economy against the 500-basis-point increase in rates over the past 18 months. For every weak manufacturing survey that is published, we find evidence of a relatively robust job market, remarkable strength in the housing market (despite lack of affordability), and diminishing inflation expectations that are contributing to a rise in consumer confidence.