Summary: In February, volatility spiked, with the VIX volatility index ending the month up more than 46% and global equity markets suffering a sharp reversal after a string of record highs recorded the previous month. Global government bonds also sold off with the move in the US more pronounced. The yield on policy-sensitive 2-year Treasury reached 2.25% for the first time since 2008 and the 10-year Treasury yield hit a level not seen since December 2013 (2.95%). The 2s10s and 5's30's yield spread curves steepened led by a greater sell-off in the back-end of the curve. Stronger-than-expected US weekly earnings data, concern over rising inflation and the possibility of the Federal Reserve (Fed) hiking interest rates more aggressively than previously expected, as well as the hawkish inaugural congressional testimony from the new Fed chair, Jay Powell, all contributed to the movements in the rates market. Toward the end of the month yields rallied, reversing some of the sell-off seen intra-month, following President Trump's remarks that he was considering placing tariffs against imported steel (25%) and aluminum (10%).
US non-farm payrolls: January nonfarm payrolls gained 200K jobs, well above the consensus estimate of 180K. A very positive surprise in the data was the return of stronger wage growth, at 0.3% (mom) in January and at 2.9% (YoY), which doesn't even fully account for the benefits stemming from the tax bill, minimum wage increases, and bonuses. The unemployment rate held steady at 4.1% (lowest since 2000).
FOMC Meeting: In its policy statement, the Fed subtly upgraded its outlook for inflation and said conditions would warrant "further" interest rate increases, suggesting that a policy rate hike at the March meeting is all but a inevitable conclusion. Overall the committee intends to keep going with normalization and was explicit on that point, but retained its "gradual" guidance. Effective February 3rd, with the new Fed Chair Jeromy Powell will assuming his post, as well as a new Vice Chair to be appointed, along with other Board seats, the composition of the FOMC at the end of the year will be meaningfully different than today.
CPI: The headline CPI print came in at 0.5% (mom) and at 2.1% (yoy), while the core measure rose 0.35% (mom) and 1.8% (yoy), above expectations. Some of the upside surprise in the January data was driven by strength in core services, specifically in shelter prices which rose by 0.3%, as well as core goods which posted strong 0.4% (mom) on the back of an unusually solid reading in apparel and residual strength in auto prices.
Portfolio Positioning: Given our view that front-end rates will be pressured higher, both the short and medium term portfolios were positioned short duration versus the benchmark. Despite the recent bout of market volatility, the management team feels that accelerating global growth, tax reform and continued strength in the U.S. economy will keep spreads supported. Consequently, the portfolios maintained underweights to lower yielding government sectors while favoring high quality spread sectors such as corporates. ABS and taxable municipals.
