MARKET COMMENTARY

2018 Fixed Income Outlook

12.22.2017 - Jeffrey S. MacDonald, CFA

On the Horizon: Bond Markets Sail into Uncharted Territory

Many developed countries expect continued economic improvements in 2018. But a key question looming over the fixed income market today is how investors will react when global central banks join the US in unwinding their massive balance sheets and raise rates. While the pace of balance sheet reduction is likely to be glacial and market reaction is expected to be muted, the sheer size of these programs and unprecedented nature of these policies introduces an element of uncertainty into the outlook.

Budget Constraints Challenge the Muni Market

We are witnessing some credit deterioration in certain parts of the market as tax revenue growth slows and budgets continue to be pressured. Tax reform could have a significant impact on the market. With these factors in mind, we still believe carefully selected municipal bonds offer attractive tax-exempt value and diversification benefits within the broader credit markets. We expect credit quality to be a focus in 2018 as the economy and policy in Washington evolve. Default risk in the near term should remain muted.

Tax Reform Could Chill Corporate Bond Issuance

In the corporate bond market, a reduction in interest tax deductibility and repatriation of earnings held overseas could reduce the desire for companies to borrow. New issuance has been rising steadily against a backdrop of strong demand, keeping yields low and credit spreads tight. Aggressively tighter monetary policy would likely cause credit spreads to widen and valuations to ease, but we expect that process to evolve slowly. Economic improvements in large, developed markets overseas could also buoy corporate yields in the US. In line with our view of global economic resynchronization, we continue to have a broadly positive view of US corporate fundamentals. Interest rates remain low, inflation muted, corporate balance sheets are solid, and debt-service costs appear manageable. Despite historically tight credit spreads, select corporates still offer attractive yields compared to US government bonds. In the corporate and muni bond markets, careful credit analysis and a high degree of selectivity are the cornerstone of our portfolio construction process.

Managing Rate Risk with Shorter Maturities

Interest rate risk remains a concern of ours. While inflation and upward yield pressures have been muted, tighter labor markets in the US and more synchronized global growth suggest both could move higher. We continue to manage interest rate risk by investing in shorter maturities, which are less sensitive to price deterioration as interest rates rise. As these bonds mature, proceeds can be reinvested at what we expect to be higher rates.

VIEW OUR FULL 2018 OUTLOOK





This analysis is provided for illustration and discussion purposes only and does not guarantee future results. Please speak to your Fiduciary Trust contact if you have questions or would like more information. This communication is intended solely to provide general information. The information and opinions stated are as of December 1, 2017, and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

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