Key points from AIM’s April 2019 market commentary
U.S. stocks had the strongest quarterly performance since 2009 with the S&P 500® Index gaining 13.07%.
The dark clouds overhanging markets throughout the first quarter appear to be breaking apart as investors realize economic conditions were not as dire as markets had peen portraying earlier in the year. On the other hand, the bond market has certainly been signaling a gloomy outlook with the Treasury curve inverting for the first time since the financial crisis, and the rates market pricing in a high probability of a rate cut at the end of the year. Time will tell whether the inversion of the 3-month and 10-year Treasury yields was a signal for weaker economic activity ahead or simply an anomaly resulting from 10 years of being in a low rate environment.
The 3-month Treasury bill yielded more than the 10-year Treasury for the first time since 2007.
After a few months of subdued levels, bond volatility surged in March following the release of the latest projections from the Fed. The communication was a dovish surprise for many investors, especially those who expected an additional rate hike later this year, as the Fed’s projection had zero rate hikes in the forecast for 2019. The change in sentiment from the Fed caused a swift repricing of Treasury bonds, sending the 10-year Treasury yield 31 basis points lower for the month. In turn, the downward pressure on longer bond yields triggered the first inversion of the yield curve since 2007 as the 3-month yield was higher than the 10-year yield for a brief period at the end of March.
Despite recession signals like the Treasury curve inverting, the U.S. economy still appears to be on solid footing as the labor market, business surveys, and consumption indicators are still fairly solid.
With the inverted Treasury curve flashing a recession warning, investors began to price in a high probability of a rate cut from the Fed by the end of the year. We think the latest movement in rates is a bit overdone, but recognize what the Fed’s dovish policy stance has done to interest rates. Thus, we now expect the 10-year Treasury to end the year in a range between 2.25% and 2.75%.
The Fed now expects to leave policy rates on hold for the rest of 2019 according to the latest summary of projections from the Federal Open Market Committee.
Perhaps the largest driver behind the divergence between stocks and bonds was the unexpected dovish shift from Fed policy members. At the March Fed meeting, the Federal Open Market Committee released the latest forecast for policy rates through the so-called “dot plot.” In the Summary of Economic Projections, the median dots for the year-end target of the Fed funds rate moved lower, leaving the committee no room for additional rate hikes later this year. The communication was a dovish surprise for investors who were expecting a rate hike later this year. The market consequently interpreted this change to mean the Fed was done raising rates in this cycle, which ultimately led to the Treasury curve inverting at the end of March.
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