- Getting back to normal? There were no major events to cause investors to
race to the safest haven of Treasuries last month and it showed in the performance
numbers. The Treasury index suffered its second consecutive monthly decline
with a drop of 1.17%. If anything, it looks as though bond investors are
refocusing on the fundamentals (as opposed to reacting to gloomy news and
fear) and they did not entirely like what they saw. Bonds sold off on renewed
inflation fears brought about in part, no doubt, by record high oil prices.
Along with those fears comes an evolving opinion on what (and when) the Fed
will do with the Fed Funds (FF) rate. We have followed the FF futures contract
table for many years. This table offers a glimpse at what investors are predicting
the Fed will do next. Two months ago, the six-month contract implied a high
probability of additional rate cuts. Today, however, the picture has changed
to the point where instead of expecting further cuts, investors are now expecting
rate hikes! It is anyone's guess what the Fed will actually do of course,
but there is no question that the mood of the market has done an about face
when it comes to Treasury investing and interest rates.
Looking at the numbers,
the biggest move was a decline in the 3-month T-bill that saw its yield
rise by 50 basis points to close the month at 1.87%. The yield on this
instrument was as low as 0.55% at one point back in March. The next biggest
mover
was
the 5-year note that saw its yield increase by 40 basis points to 3.41%.
The yield on the 10-year closed out at 4.06%. The last time we saw
a "4
handle" on the 10-year was back at year-end 2007 when it closed at
4.02%. The total return on the 10-year benchmark now stands at only 1.20%
after having given back 1.96% of performance in April.
- The Treasury Inflation
Protected Securities (TIPS) market is the best performing fixed-income
sector thus far in 2008. It is also comfortably ahead of the Lehman Aggregate
Bond
Index over both five and 10-year time frames. However, there are
times when the short-term behavior of this asset class can be somewhat
mystifying.
Currently,
the bond market seems to be questioning whether the Fed can fight
three battles simultaneously (the liquidity battle, the economic recovery
battle, and the
inflation battle). It is the inflation battle, of course, that
should most directly impact the TIPS market. As May drew to a close, Bill
Gross
of PIMCO - the
biggest bond manager in the world - questioned the validity of the
inputs the government uses in determining domestic inflation, and concluded
that we are understating inflation, perhaps substantially. Whether we are
or not is an argument I'll leave for others, but if we are "losing" the
inflation battle, TIPS ought to benefit (at least relative to nominal Treasuries).
Yet on the day that Bill's missive came out, TIPS experienced a sharp
and pronounced sell-off! Despite such apparent anomalies, over the long haul,
it is hard to argue against their performance.
- The Supreme Court finally
made their ruling in the "Kentucky" case and it was
great news for the status quo. In short, the Court overturned
a lower court ruling that
challenged the current system of exempting the interest income
from bonds issued inside of state boundaries, while taxing
the interest income from
bonds issued outside of state boundaries. Forty-nine states
filed ‘friend-of-the-court
briefs' in support of Kentucky and the current way of
doing business in municipal finance. This is good news for
a market that
had been
uncharacteristically volatile in the first few months of the
year, but seems to have gotten
back on track in the past month or so.
| Lehman
Fixed Income Index Returns Through 5/31/08 |
| Lehman Index |
Duration |
May |
YTD |
Ret
. '07 |
Ret.
'06 |
Ret.
'.05 |
Ret.
'04 |
| US T Bill Index |
0.26 |
0.04 |
% |
1.08 |
% |
5.01 |
% |
4.82 |
% |
3.05 |
% |
1.24 |
% |
| US Treasury Index |
5.17 |
-1.17 |
|
1.43 |
|
9.01 |
|
3.08 |
|
2.79 |
|
3.54 |
|
| US TIPS Index |
5.84 |
0.33 |
|
3.30 |
|
11.63 |
|
0.41 |
|
2.84 |
|
8.46 |
|
| US Aggregate Bond Index |
4.46 |
-0.73 |
|
1.21 |
|
6.97 |
|
4.33 |
|
2.43 |
|
4.34 |
|
| US Govt/Credit Index |
5.33 |
-1.03 |
|
0.88 |
|
7.23 |
|
3.78 |
|
2.37 |
|
4.19 |
|
| US Credit Index {A2} |
6.23 |
-0.94 |
|
0.05 |
|
5.11 |
|
4.26 |
|
1.96 |
|
5.24 |
|
| US High Yield Index {B1} |
4.49 |
0.36 |
|
1.53 |
|
1.87 |
|
11.85 |
|
2.74 |
|
11.13 |
|
| Caa Component |
4.55 |
1.37 |
|
1.28 |
|
-0.13 |
|
17.66 |
|
0.64 |
|
13.80 |
|
| Emerging Market ($$) {BA2} |
6.71 |
0.38 |
|
1.80 |
|
5.21 |
|
9.96 |
|
12.27 |
|
11.89 |
|
| Municipal Index |
7.81 |
0.61 |
|
1.16 |
|
3.36 |
|
4.84 |
|
3.51 |
|
4.48 |
|
| Municipal Index - 5 Year |
4.04 |
0.31 |
|
2.15 |
|
5.15 |
|
3.34 |
|
0.95 |
|
2.72 |
|
Christopher Keith
Fixed-Income Manager
|
