Compression

by

Summary

Year-to-Date Last 30 Days

Treasuries 8.69% -0.47%

Corporates 2.26% 0.80%

High Yield -6.41% 3.43%

Munis 1.03% 2.19%

*Data according to Bloomberg

Utilizing this chart, you can see what is happening. Risk assets are compressing to Treasuries. This is what I have suggested would happen for some months now. Part of this, of course, has been the "Fear Factor," as our coronavirus pandemic pushed Treasury prices higher and higher as a run towards the safest of havens. The run has been balanced by the government's borrowings, as they head higher, and higher, as Congress and the Administration, pushed vast quantities of money out into the system to combat a very troubled economy.

Another significant factor has been the Fed. They are now buying ETFs, corporate bonds soon, high yield bonds on the way, and they have expanded their base of investments to areas never seen before in their portfolios. In fact, their assets now exceed $6.6 trillion which is the biggest balance sheet of any of the major central banks. I would also state that there is no end in sight here, as the Fed has stepped in, along with the government, to support the markets in a time of both a medical and a financial crisis.

In terms of hard data, the U.S. reports April's income and consumption figures this coming week. April has already been written off, and economic forecasts are sobering, if not scary. The three regional Fed GDP trackers (St. Louis, New York, Atlanta) range from an annualized contraction in Q2 of 31%-48%. Personal consumption expenditures are projected to have fallen by around 12.5% after a 7.5% decline in March. April's income is expected to have fallen around 6.5%-7.0%.

There is no precedent in post-World War II American history that's even close to what Congress has done. They have passed $3 trillion in stimulus, which is 14% of GDP. It is vastly larger than anything they've ever done. - Fed Chairman, Jerome Powell

The Fed targets the PCE deflator at 2% and often talks about the core rate. The headline rare will move further away from the 2% target. It may fall from 1.3% to 1.0%, and the core rate may slide to 1.1% from 1.7%. It is clear from Fed officials' comments that supporting the economy is the number one priority. With industrial capacity utilization rates below 65% and unemployment on its way above 20%, inflation pressures will likely remain subdued and, in fact, I suggest that there may be some deflation on the horizon.

We have lowered interest rates to near zero in order to bring down borrowing costs. We have also committed to keeping rates at this low level until we are confident that the economy has weathered the storm. - Fed Chairman, Jerome Powell

What is also clear to me is that rates, for any asset class, will not be going up again anytime soon. The amount of debt, being accumulated by the U.S. government, will also not be falling again anytime soon, as I said, and so the Fed is setting the bar to keep interest rates quite low as an off-set to the government's actions.

This is creating a dilemma for bond buyers and fixed-income investors as they cannot get the returns, they need, to support their businesses or their lifestyles. This is hitting the life insurance companies, pension funds, seniors, retirees, and others who depends upon bond yields for their income stream. On the flip side it is a boon for mortgages, corporate borrowings, bank loans and it has created a kind of "Borrower's Paradise." Even when assessing an equity, it is now important to realize that a company's lowered borrowing costs will be a help to their bottom line and profits.

I also point to the equity markets as being helped along by the bond markets. It is clear to me, as yields decline, that many people, and institutions, are now turning to the equity markets as a way to get income when little can be found in the bond markets. Plays for appreciation are becoming an off-set to the fixed-income markets though, it should be noted, that this is increasing the risk, for these investors.

Even when looking at the closed-end funds, where I currently like about fifteen, with monthly payments and double digit yields, their leverage is a consideration. The cost of the leverage now, in my opinion, will be going down which will be an added benefit to these instruments. The two factors here are the amount of leverage and the cost of carrying it. The cost savings here will accrue to their Net Asset Value and that is certainly a positive.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.