Client Communication

Fixed Income Report 2Q19

Should expectations for second quarter economic growth of approximately 1.5% prove correct, the current U.S. economic expansion will become the longest in history according to the National Bureau of Economic Research. Typically this should be something to cheer, yet the bond market appears to be viewing the length and slowing pace of growth as a sign of imminent demise. Aside from the tenure, it has been a rather lackluster expansion from a historical perspective, with an average growth rate of just over 2%. While the lower-for-longer journey means that not much of a turn downward would be needed for a contraction in growth, it is also an indication that few excesses have developed along the way.

The souring economic outlook has not been lost on the Federal Reserve Bank (Fed). Citing concerns over decelerating global growth and the potential negative impact of continuing trade disputes, the Fed pivoted sharply at its June Federal Open Market Committee (FOMC) meeting. They indicated that a cut in the Fed Funds rate is likely in coming months. This ‘dovish’ shift accelerated the decline in Treasury bond yields, capping a 51 basis point decline in the 2-year Treasury Note from 2.26% to 1.75%, and a 41 basis point decline in the 10-year Treasury Note from 2.41% to 2.00% during the quarter.

Returns were notably strong given the sharp decline in yields. The Bloomberg/Barclays Aggregate Index® generated a 3.08% return during the quarter, and the Bloomberg/Barclays Government/Credit Index® tallied 2.59%. While the sharp decline in yields was the primary driver of returns, stable credit spreads on risk assets were additive as well.

With the Fed and other global central banks indicating a pivot toward more accommodative monetary policy, the debate has shifted to how many rate cuts are in the offing. Current pricing in forward markets suggest the Fed will reduce the Fed Funds rate by as much as 100 basis points over the next twelve months. In our view, the Fed is more likely to be less aggressive with only a modest “insurance” easing in the next few quarters. We expect they will be inclined to make one or two 0.25% cuts in the Funds rate over the course of the next several months while carefully monitoring economic activity.

The implications of these conflicting views are significant. The more aggressive rate cutting outlook currently present in the market seems to suggest a serious slowdown or contraction in domestic growth which would be a positive for the short end of the yield curve. Conversely, a less aggressive “insurance” approach implies that moderate economic growth remains the base case. The implication of this more measured approach would put pressure on longer Treasury yields, which have discounted too much bad news. We suspect the latter scenario to play out over the months ahead.

The final arbiter is likely to be just how deep and drawn out trade conflicts become. There is little doubt that the uncertainty and disruption of the disputes have restrained supply chains, input costs, business planning and confidence. While the recent truce between the U.S. and China brokered at the just concluded G-20 meeting was welcome, we recognize that uncertainty will persist until a deal is finalized.

In essence, we do not believe that the current level of interest rates are restrictive by any historical measure. Rather, they are under pressure due to the ongoing uncertainty related to the impacts of trade on the economy. This, in turn, has put the Fed in the awkward position of responding earlier than hoped and with less than perfect information. We believe the Fed will adopt a more cautious approach to cutting rates than current Treasury yields are discounting.

Equity markets and the current level of credit spreads are not projecting the same expectation of a slowdown in economic activity as Treasury yields are indicating. While we suspect interest rates likely peaked last fall for the current cycle, the current level of rates appears overly dour in our view. Volatility around trade, still elevated geopolitical risk on multiple fronts and noisy economic data will likely persist. We believe we will have opportunities to extend maturities at higher and more attractive yields than current levels offer. While maintaining a shorter duration posture has been painful, we continue to believe that this strategy, along with a selective

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  • “Madison” and/or “Madison Investments” is the unifying tradename of Madison Investment Holdings, Inc., Madison Asset Management, LLC, and Madison Investment Advisors, LLC, which also includes the Madison Scottsdale office. Madison Funds are distributed by MFD Distributor, LLC. Madison is registered as an investment adviser with the U.S. Securities and Exchange Commission. MFD Distributor, LLC is registered with the U.S. Securities and Exchange Commission as a broker-dealer and is a member firm of the Financial Industry Regulatory Authority. The home office for each firm listed above is 550 Science Drive, Madison, WI 53711. Madison's toll-free number is 800-767-0300.

    Any performance data shown represents past performance. Past performance is no guarantee of future results.

    Non-deposit investment products are not federally insured, involve investment risk, may lose value and are not obligations of, or guaranteed by, any financial institution. Investment returns and principal value will fluctuate.

    This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.

    Although the information in this report has been obtained from sources that the firm believes to be reliable, we do not guarantee its accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitute the firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.

    In addition to the ongoing market risk applicable to portfolio securities, bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally, the longer a bond’s maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which allows the issuer to retain the right to redeem the debt, fully or partially, before the scheduled maturity date. Proceeds from sales prior to maturity may be more or less than originally invested due to changes in market conditions or changes in the credit quality of the issuer.

    Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only, and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance.

  • Bloomberg Barclays U.S. Government/Credit Bond Index includes securities in the Government and Corporate Indices. Specifically, the Government Index includes treasuries (i.e., public obligations of the U.S. Treasury that have remaining maturities of more than one year) and agencies (i.e., publicly issued debt of U.S. Government agencies, quasi-federal corporations, and corporate or foreign debt guaranteed by the U.S. Government).

    The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, mortgage backed securities, asset-backed securities and corporate securities, with maturities greater than one year.

    The Bloomberg Barclays Global Aggregate Bond Index is a flagship measure of global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.

    The Bloomberg Barclays Intermediate Govt/Credit Bond Unmanaged index that tracks the performance of intermediate term US government and corporate bonds.

    The Citigroup Economic Surprise Indices are measures of economic news. They are defined as weighted historical standard deviations of data surprises.

    The S&P 500® is an unmanaged index of large companies, and is widely regarded as a standard for measuring large-cap and mid-cap U.S. stock-market performance. Results assume the reinvestment of all capital gain and dividend distributions. An investment cannot be made directly into an index.

    The Bloomberg Barclays Global High Yield Index is a multi-currency flagship measure of the global high yield debt market. The index represents the union of the US High Yield, the Pan-European High Yield, and Emerging Markets (EM) Hard Currency High Yield Indices. The high yield and emerging markets sub-components are mutually exclusive.

    Bloomberg Barclays US Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market.

    This piece is not intended to provide investment advice directly to investors.Opinions stated are informational only and should not be taken as investment recommendation or advice of any kind whatsoever (whether impartial or otherwise).

    ©Madison Investment Advisors, LLC. July 11, 2019


  • “Madison” and/or “Madison Investments” is the unifying tradename of Madison Investment Holdings, Inc., Madison Asset Management, LLC, and Madison Investment Advisors, LLC, which also includes the Madison Scottsdale office.  Madison Funds are distributed by MFD Distributor, LLC.  Madison is registered as an investment adviser with the U.S. Securities and Exchange Commission.  MFD Distributor, LLC is registered with the U.S. Securities and Exchange Commission as a broker-dealer, and is a member firm of the Financial Industry Regulatory Authority. 

    Madison Investments shares all personnel and resources at their Madison, Wisconsin location. Statistical data is for the consolidated Madison organization. The Madison organization consists of its holding company, Madison Investment Holdings, Inc. and its affiliates: Madison Asset Management, LLC; Madison Investment Advisors, LLC; and Hansberger Growth Investors, LP. Asset information presented includes non-discretionary assets. Refer to each entity’s Disclosure Brochure for more information.

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