Bond Market Observations: Carry On Don't Lose Your Head

The film of the title was one of 31 low-budget comedies churned out by Pinewood Studios. If you remember them, you are probably from a Commonwealth country and you have definitely dated yourself. The general principle, though, succinctly summarizes our investment advice. Look for opportunities to pick up extra return, selectively, but maintain a relatively lean risk budget, emphasize more liquid risk factors, and take advantage of low volatility to buy interest-rate protection cheaply. Pick up carry but don’t lose your head.

Why do we think so? In part, it is our outlook for the global economy. Activity in advanced economies trundles along, a bit more in lockstep than previously this decade. In the US, real GDP has been stuck in a growth channel centered at 2 percent since 2010. Sometimes, we are at the low end, as in the first quarter of this year. Sometimes, we are at the high end, as in this and the prior quarter.

To be sure, a good bit of air has leaked from the hope-filled balloon representing the Trump economic agenda. As the President’s approval rating sagged, economists moved from being positively surprised about incoming economic data to mildly disappointed. However, market economies adjust to such news and we have easier financial conditions today than would have been the case if a signing ceremony in the Rose Garden for tax-and-infrastructure reform were in view.

Important in those adjustments has been the depreciation of the foreign exchange value of the dollar, which rolled back the modest post-election bump and then some. In retrospect, the earlier appreciation, which made exports from the US more expensive and imports to it cheaper, imparted a bigger boost to activity in our trading partners and a longer-lived drag on US inflation. The turndown in the dollar, and the possibility that it will extend, lends some reassurance that inflation will pick up. Here, reassurance is welcome, as inflation has disappointed five months in a row.

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