The highlights of last week were the dovish comments by Federal Reserve Chair Janet Yellen and the solid March employment report. The Fed Chair's dovish posture is not new news, but with each opportunity Yellen continues to reinforce her view. She believes the Fed can be deliberate in raising interest rates because of downside economic risks and international pressures. Accommodative monetary policy across the globe continues to support risk asset valuations and has helped equities recover the losses experienced in January and February of this year. The March employment report was solid despite an increase in the unemployment rate to 5.0%. On the positive side, March job gains remain solid with 215,000 new jobs being added and an increase of 0.3% in average hourly earnings.
I continue to remain cautious on long duration fixed income assets due to my belief that inflation will pick up over the remainder of this year and that even a modest increase accompanied by an accommodative Fed could put significant pressure on bond prices. As an example: The current 30 year receiver swap rate is 2.13%. This means you can receive 2.13% for the next 30 years while paying 3 month LIBOR (0.63% currently) on a floating rate basis. To me, the spread of 1.5% is not enough to compensate for the risk of rising inflation in the next twelve months. To put this example into perspective, a 50 basis point increase in long-term market rates over the next year would lead to an approximately negative 8.5% return. If the Fed is intent on getting inflation to its 2% target level, then the price risk inherent with this type of position is significant. Look for inflation-hedged securities such as Treasury Inflation Protected securities as an alternative in this environment.
It has been a very tough time to be a Philadelphia sports fan over the past few years, but Villanova has a great chance to bring winning back to the area. Good luck on tonight versus North Carolina!!! Go Wildcats!!!
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