Bond Market Observations: Pilgrims' Progress?

A seasonal mystery unfolds once again. Here in Boston, it is cold, wet, and mostly dark. Winter is coming. What made the Pilgrims stop here in 1620, rather than settle, say, Tucson or Palm Springs? Why do 670,000 of us still live here when Fort Lauderdale or New Orleans provides viable alternatives? One suspicion is that a human defense mechanism pushes inconvenient and irreversible facts to the back of our collective minds. With the disadvantages shrouded by this unconscious protective device, we see opportunities, such as the North End, Parker House rolls, and our sports franchises, and remain hunkered down in anticipation of snow.

As Boston-based investors, we worry the same mechanism keeping us here also influences our portfolio choices. However many ways we fret about the risks and vulnerabilities of the settled world order, the world seems, well, settled as viewed from financial markets. Actual and implied price volatilities of most assets are quite low. In that environment, opportunities to pick up some carry poke above the cloud cover of concerns. The core question for investment professionals: Are we desensitized (and unwise to pluck those opportunities and tilt a little more toward risk) or sensible (in looking for opportunities, when pricing merits, to add a little meat to our lean risk budget)?

For now, we have convinced ourselves of the appropriateness of our call that bouts of volatility will be just that, bouts that relatively quickly reverse in the pattern of the past few years. When they flare, take the opportunity to pick up carry, emphasizing quality. That said, the dial on the meter of the risk budget is short of center and we favor buying rate protection for outsized events given that markets price it so inexpensively.

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