Markets had become particularly frothy over the past few quarters as global quantitative easing programs drove investors farther into risky assets. Across fixed income markets, our models showed most sectors as rich to fair value, to a degree not seen in quite some time. Several recent events are, however, providing the potential to finally loosen up some opportunities in the market. The quote above thus reminds us that even though there is turmoil in the market it may not be sufficient yet to raise our muskets. Closely following the Grexit drama are impending Fed rate hikes, even if the market shows skepticism with regard to the timing suggested by the Fed “dots”. China is another wild card as a slowing economy and fickle equity market contributes to volatility. As the quarter drew to an end, valuations began to cheapen somewhat and long corporate bonds in particular looked attractive with a historically steep credit curve. Pension plans have for the most part been on the sidelines after absorbing the higher liabilities and lower funded status resulting from implementing updated mortality tables. The resulting absence of new flows partly explains the historically steep credit curve.
Only last month it seemed as though financial market participants were solely focused on scrutinizing every detail pertaining to U.S. rate moves, whether it were a change in Fed statement messaging, a shift in the Fed “dots”, or Janet Yellen’s facial expressions and body language; literally any piece of information that could provide a higher probability of the first rate hike on a particular month. Such analysis has fallen to the wayside as Greece concerns now lead a much more prominent role in the near and medium term direction of the markets. Perhaps it took an instigator of greater volatility to provide the perspective that a short term rate increase of 25 basis points is merely that, and the exact timing of that increase, whether it be September, December, or even 2016, may be less consequential than more serious geopolitical concerns in Europe and developing powers like China.
Other troubles are also brewing in the western hemisphere. Prices on Puerto Rico’s General Obligation (GO) bonds fell to record lows after the Governor was quoted saying that “The debt is not payable”. Such a default may pierce the veil of perceived relative safety in local government GO bonds. General volatility also seems to be impacting U.S. corporate bond spreads, which have now widened out nearly 50 basis points since the tights of last year. Even if volatility tempers somewhat, spreads may continue to be under pressure as the record pace of issuance is expected to persist through the summer.