Expect bond market waters to stay 'muddy'

Expect bond market waters to stay 'muddy'

Expect bond market waters to stay

Waters will stay muddy for a while as markets deal with the aftermath of the US government shutdown, according to a fixed-income specialist.

Kevin Flanagan, senior fixed income strategist, believes patience will be needed from investors as both the Federal Reserve and bond market have not been receiving any fresh insights on the economy. This could eventually indicate a sudden downpour of data, which will complicate forecasts.

He said: “Once the government agencies are caught up, history has shown us that a data deluge could be on the horizon, as two months’ worth of reports could get released on the same day.

“A further complication is that Q1 real GDP will more than likely be adversely impacted to some degree by the shutdown—and Q2 should show a bounce-back. This means the Fed may not get a true sense of underlying conditions until later in the spring.”

With that in mind, Flanagan is sticking to a US growth slowdown rather than a recession and a delay in rate decisions thanks to the shutdown.

He said: “Eventually, we feel that should lead to at least one more rate hike this year, but the timing has probably been pushed out due to the aforementioned considerations. Don’t forget about the balance sheet. I’m expecting more headlines on this front as 2019 progresses.”

Flanagan added that the first Federal Open Market Committee (FOMC) meeting of 2019 provided a policy statement and further evidence the Fed is going about things in a different way than investors have become accustomed to, albeit a return to how it “typically conducts monetary policy when the Fed Funds Rate target is not zero”.

He added: “Since the FOMC began raising rates in December 2015, and picked up the pace during the last two years, the plan was to move the Fed Funds Rate target away from zero, i.e., to normalize policy.

“Now, with the upper band of the policy rate target at 2.5%, or close to what is considered a neutral rate, the voting members have achieved their goal. So instead of raising rates in a somewhat gradual, but more importantly, predictable manner, further possible rate hikes will hinge upon upcoming economic data. In other words, monetary policy has become data-dependent.

“This is how the FOMC typically went about its business prior to the global financial crisis/great recession.”

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