Calendar 2019 was an interesting and unexpected year in the fixed income market. After four interest rate increases in 2018, it was widely expected that the Federal Reserve would continue to tighten the money supply in order to regain a “normal” interest rate yield curve. Entering the year with the Trump tax cuts and regulatory reform in full swing, the U.S. economy was booming like never before. However, the outcome in rates by year-end was not as expected.
March 2019 proved to be the inflection point in the U.S. fixed income market. The benchmark 10-year yield decreased from a high of 2.75% in early March to a low of 2.36% at the end of the month and ended the year at 1.91%. The reasons for the decrease in rates were numerous.
First and foremost was the Fed. The Fed announced early in the year that they had capitulated on further rate hikes. The “data dependent” phrase and wait and see attitude removed any probability of another rate hike in 2019. Immediately after their March meeting, markets reflected greater odds of future rate decreases than increases. Soon the Federal Reserve reversed course and started the easing cycle again. By year-end, the Fed had lowered the Fed Funds rate to a range of 1.50-1.75%.
The second factor was the general weakness in the European Union, particularly Germany. The largest economy in the EU, Germany also removed any thought of normalizing interest rates as the year progressed. The German 10- year Bund rate fell below zero once again. This was noteworthy because markets were under the impression that previous extraordinary accommodative steps taken by EU members were ending. In fact, just the opposite was the case. The Germans were basically admitting that their economy was moribund, and historically low interest rates were here to stay.
Economic weakness began to take hold worldwide by late summer, and fear of the U.S. getting caught in the downturn drove bond yields lower everywhere. The U.S. yield curve inverted in August, with long term interest rates briefly lower than short term rates. To many, this inversion was a signal of the end of the U.S. expansion. As we know though, this did not happen. The U.S. economy showed great resilience. Key indicators, including consumer spending and employment remained robust. The current unemployment rate of 3.5% is the lowest rate in over 60 years, and key economic indicators such as consumer confidence and wage growth remain near 20-year highs.
Looking ahead to 2020, the U.S. continues to be the best house in a mediocre (at best) economic neighborhood. The China tariff war has cooled a bit, and this should give a boost to corporate confidence and capital spending, two economic weak points over the past 6 months or so. The Phase One trade agreement is positive, but we will have to wait to see if it has any “teeth”. Meanwhile the coronavirus outbreak in China has offset some of the nascent optimism, having dented travel and energy markets around the world. Only time will tell if it becomes a bigger issue for the U.S. economy.