In a much anticipated move last week, the Federal Reserve (Fed) increased short-term interest rates by 25 basis points (bps). The Fed also outlined parameters for shrinking its $4.5 trillion balance sheet. Once the process begins, it is expected to take at least four years to reduce the balance sheet by approximately $2-2.5 trillion.
While the Fed provided significant news, the largest market moving activity in the U.S. occurred before the Fed announcement as a weak retail sales report and a disappointing inflation report caught the bond market off guard. Retail sales for May fell 0.3% after economists predicted sales to hold steady at previous amounts. The CPI fell by 0.1% to bring the annual increase in inflation, excluding food and energy, to 1.7% from an average annual increase over the past decade of 1.8%. The fall has inflation trending lower from the Fed's target of 2%.
Concerns about inflation expectations should be watched closely in the months ahead as global asset prices would be supported by a modest amount of inflation and real growth. The Fed has been working to normalize monetary policy in a world that still has a significant amount of debt trading with negative interest rates and most developed countries are more concerned about deflation. The Fed would like to see the yield curve (the difference between short- and long-term interest rates) at a steady level as it normalizes monetary policy; however, the yield spread between 2- and 10-year Treasury yields has been compressing this year.
I will closely be watching two indicators for warning signs for future economic growth: the yield curve and credit spreads. The flattening of the yield curve is worth watching because if it continues to flatten, the road ahead for the economy and stocks could become more challenging. Credit spreads are trading at the tightest level in the last decade and have seen very little volatility.
This blog post is for informational use only. The views expressed are those of the author(s), and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Any statements about financial and company performance of The Penn Mutual Life Insurance Company or its insurance subsidiaries (each, “Client”) made by the author is provided with a written consent from the Client. Penn Mutual Asset Management is a wholly owned subsidiary of The Penn Mutual Life Insurance Company.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results. All information referenced in preparation of this material has been obtained from sources believed to be reliable, but accuracy and completeness are not guaranteed. There is no representation or warranty as to the accuracy of the information and Penn Mutual Asset Management shall have no liability for decisions based upon such information.
High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.
All trademarks are the property of their respective owners. This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission.