M A R K E T C O M M E N TA R Y

US Market Watch
Markus Schomer, CFA, Chief Economist
April 2014

OVERVIEW
There was not much of a honeymoon period for new Federal Reserve Chairwoman Janet Yellen. During her rst solo press conference, where she presented the Federal Open Market Committees (FOMC) decision to continue tapering QE3 by US $10 billion per month, bringing the monthly asset purchases target for April to US $55 billion, she was asked how long of a gap we might expect from the end of bond buying to the rst rate increase. Her response, probablysomething on the order of around six months, caused only a mild drop in stocks, but seems to have pushed up two-year yields permanently by about 15 basis points. That suggests that market expectations of future rate increases the main driver of twoyear yields did adjust after Yellens statement. Call it an early wake-up call. Most investors seemingly were looking at a rate hike cycle start date deeper into the second half of 2015. Yellens comments pulled those expectations slightly forward.

fact that ination is not only well below the Feds 2% to 2.5% target range, but still trending further away. Supporting the ination argument is the bullish trend in 30-year yields, which have easily outperformed the rest of the yield curve in the rst quarter.

MARKETS
Despite more tapering in March, 10-year US Treasury yields have remained in a very tight range between 2.6% and 2.8% since the end of January. In fact, we ended the rst quarter only a few basis points off of our 2.75% forecast. One argument I heard at a recent client event is that despite reduced Fed buying, weaker US macro data as the economy went through the icy patch and safe-haven ows as a result of the crisis in Crimea have kept yields temporarily low. That may have played a role in keeping Treasuries subdued. However, the main driver, in my view, is the continued absence of ination. The PCE Deator, the Feds preferred ination gauge, fell back below 1%, highlighting the

US stocks ended the rst quarter on a high. The S&P 500 actually set a new record, while the Dow Jones traded close to its December high. Tapering, the icy patch and the crisis in Crimea should all have dampened the upside momentum for risk assets. Yet, equity investors seem unfazed and are rather buying into expectations of a stronger spring rebound in the economy and improving global growth conditions. Fixed income credit markets posted generally positive performance in March. US high yield and investment grade added only a little to their strong gains of February. Meanwhile, emerging markets (EM) xed income enjoyed further buoyant gains, taking the rst quarter performance to 3.7%. The US dollar strengthened slightly in March. Among the majors, the Japanese yen lost nearly 2% in the run-up to the consumption tax increase, and most of the European currencies were little changed. The biggest gainers were the New Zealand and Aussie dollars both up between 3% and 3.5% and, interestingly, the fragile ve currencies, which managed nearly 3% against the US dollar.

growth will fall back below 2%. However, survey results point to a rebounding momentum toward the end of the quarter. The two key manufacturing surveys have been quite volatile, but are, at least, pointing to moderate output growth after a period of weak business spending over this winter. One of the two key US consumer condence surveys reached a new postrecession high in March the other one is not trading far away from it suggesting that neither the cold nor the negative perceptions about the job market have diminished consumers outlook. We will be looking for evidence of a rebound in private sector demand in the factory orders and retail sales numbers. Housing has been even more volatile in recent months, with sales gures in particular not seeing much evidence of a rebound. Yet, sales contracts signed in March and April published with at least a months lag should start to pick up convincingly with the typically stronger spring selling season. All in all, we are still looking for a reacceleration in US economic growth to 2.7% in the spring quarter, reaching 3% in the second half of the year.

POLITICS
The Federal Reserve continued to taper its asset purchase program in March. In her press conference, Janet Yellen reiterated the FOMCs ofcial line that asset purchases are not on a preset course, and...their pace will remain contingent on the Committees outlook for the labor market and ination. Yet, the third consecutive meeting that ended with a US $10 billion QE3 reduction has established a pattern that at least implicitly is now part of the Feds forward guidance. If the Committee was not swayed by weaker economic data, slowing ination and rising geopolitical risks, then the hurdle to slow the pace of tapering is indeed quite high, as we had assumed all along.

ECONOMY
It is still too early to sound the all clear, blame the slowdown in the rst quarter entirely on the weather and expect a return to the 4% growth trend of the third quarter of last year. We will get conrmation of the damage caused by the icy patch in a few weeks with the release of the rst quarter GDP report. We expect

The Fed also moved away from quantitative guidance represented by the previous 6.5% unemployment rate threshold for raising rates toward a more orthodox commitment to take into account a wide range of information in the assessment of the progress toward the Feds two goals of maximum employment and 2% ination. Rather than making the decision datadependent, we are back at being mainly time-dependent, as the sentence it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends highlights. Having said that, as the above mentioned response to the question what considerable time may mean showed, it is not as vague as it may sound. Assuming further US $10 billion tapering decisions in each of the remaining six meetings this year, QE3 would ofcially end on January 1, 2015. Six months later in July of 2015 rate hikes could be on the table. Indeed, our forecasts expect consumer price index (CPI) ination at 2.2% and the PCE Deator at 1.9% in July 2015 and the unemployment rate falling below 6%, which seems a good trigger to start the rate normalization process.

-2% average of the past three years to nearly 2% growth by 2017. The US midterm elections are still seven months out, but polling suggests that the chances of a Republican controlled Congress have risen steadily in recent weeks. Meanwhile, the latest Republican budget proposal shows no change in focus. The party is still targeting substantial spending reductions, which suggests that future budget compromises, such as the one that brought us this years budget, will include very little in additional outlays. Hence, government spending is likely to remain a slight headwind to overall economic growth in the next few years.

Markus Schomer, CFA Chief Economist PineBridge Investments New York

Markus Schomer is responsible for providing macroeconomic forecasts, analysis and commentary for all PineBridge Investments groups, with a focus on global economic trends and their impact on nancial markets. He holds degrees in Economics from the University of Bonn in Germany and the University of East Anglia in the UK. He also studied at the London School of Economics and is a CFA charterholder.

INTEREST RATE STRATEGY

Our own US Duration Strategy framework turned less bullish last month. Fundamentals improved slightly on the back of a more bond friendly macro news ow. Yet, both our valuation and market technical score deteriorated on the back of a renewed decline in US real yields and weaker trend momentum. Overall, the framework is more rmly in the duration neutral range.

is likely to remain quite slow, due to the expected absence of ination pressures in this business cycle. Hence, we see the funds rate reaching 1% at the end of 2015 and 2% at the end of 2016.

Fiscal policy has slipped off of the front pages, but it may be too early to look for easing austerity. My intermediate-term US growth forecasts assume a steady pickup in government spending from the

Our US interest rate forecasts remained unchanged last month. We still expect policy rates to remain at quasi-zero through the summer of next year and have penciled in a rst rate increase in the third quarter of 2015. The pace of rate increases

Ten-year Treasury yields remain within our forecast range. We had expected yields to trade around 2.75% for much of the rst six month of the year before evidence of stronger economic growth begins to gradually push yields higher. That forecast has not changed. Given the lack of ination and our expectation of only gradual Fed stimulus withdrawal, upward pressure on 10-year yields should also remain muted. Hence, our forecast of yields drifting up to 3.25% at the end of this year and 4% by the end of 2015. Written on 2 April 2014

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