Eagle Asset Management | Fixed Income Investment Team
As stimulus programs expire, Fed activity bears watching
The COVID-19 economy and financial markets are being influenced by behavioral changes and monetary and fiscal stimulus. The former affects the level of real economic activity, while the latter influences asset prices. In the next few quarters, we believe the Federal Reserve’s (Fed) support of credit and interest rates will lead to an unprecedented level of liquidity in capital markets. This liquidity will continue to drive asset prices — and asset price correlations — higher. The next signpost for duration and depth of Fed monetary activity occurs at the end of the third quarter, when many programs are set to expire. We believe political and populist pushback will begin to appear in our national dialogue. While we believe fiscal programs have targeted individuals to good effect, the majority of the policy support measures have targeted markets and financial assets.
Of particular concern is the Fed’s execution of individual bond purchases. While broad support of the credit markets was necessary in March when financial conditions collapsed, targeting individual issuers carries even more moral hazard than actions already taken. Within the BBB-rated bond sector, the largest component of the investment-grade universe, credit matrices are widely disparate. Spreads during COVID-19 reflect this reality. Investors should be mindful that with record bond issuance on an already leveraged corporate sector, Fed liquidity support will not make insolvent enterprises viable. Credit research and selection is critical.
As the economy returns to “normal,” the most valuable data series is continuing jobless claims. Approximately 4.5 million companies applied for the Payroll Protection Plan and rehiring is a condition of that aid. How quickly labor markets can heal is key to returning to sustainable economic growth.
The 10-year U.S. Treasury has been locked in a very narrow range during this period, supported by $120 billion of monthly bond purchases from the Fed. If and when this slows, we expect a modest increase in 10-year yields. On the equity side, retail traders have emerged as the marginal buyer. It bears watching how this phenomena plays out over the coming quarters. In the meantime, our focus is on deep dives into balance sheets, free cash flow, and corporate strategy to ensure investment income expectations of interest payments or dividends are met in our portfolios.
While we collectively watch the daily developments in infection data along with treatment and vaccine research, we fully expect that we have moved past lockdowns and are moving into an “adapt, modify, monitor” phase.
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