Highlights
• High yield corporates performed best among taxable sectors, and emerging markets also rallied.
• High grade and high yield municipal bonds posted strong returns.
• All securitized sectors finished with positive returns, led by mortgage-backed securities.
U.S. Treasury yields declined modestly last week, led by the 5- and 10- year portions of the yield curve. Federal Reserve (Fed) comments led some investors to conclude that the hiking cycle may end sooner than originally thought. And hopes remained high that the U.S. and China could reach agreement on tariffs. The market expects fewer than two additional Fed rate increases in 2019 after a likely hike in December.
Fed Communications Push Treasury Rates Lower
Treasury rates moved modestly lower on comments from Fed officials and the November meeting minutes.1 Markets interpreted the communications as potentially indicating that the current hiking cycle could be nearing an end. The 5-year Treasury yield led the move lower.1 The 10-year followed closely and closed below 3 percent for the first time since mid-September.1 The yield difference between the 10- and 2-year Treasuries fell below 20 basis points (bps), approaching the 2018 low and the narrowest differential since July 2007.1
Market risk tone improved last week, but not all non-Treasury sectors benefited. Preferred securities suffered the worst performance, followed by senior loans and investment grade corporates.1 All three sectors experienced negative total returns and underperformed Treasuries.1Within the investment grade corporate market, the energy sector saw the worst performance.1Similarly, the high yield energy sector lagged.1 But strong returns in the telecommunications and construction sectors more than offset the energy-related drag.1 As a result, high yield corporates posted the highest total return of the week.1 Emerging markets also delivered a solid return, behind only high yield and mortgage-backed securities.1
Fed Chair Powell commented that interest rates “remain just below the broad range of estimates of the level that would be neutral for the economy.” Likewise, November’s meeting minutes discussed moving toward language focused on the evaluation of incoming data. Both communications reinforce our belief that the Fed is approaching a pause in policy adjustment. Market-based probabilities now reflect fewer than two additional increases in 2019 after the December hike.
Municipals Finish 2018 Strong