Eric Stein

Despite continued growth and inflation, long rates back off first-quarter highs, as outlined by Eric Stein, Eaton Vance chief investment officer, fixed income, in his latest commentary.

Mr Stein notes: “The markets got a bit overextended with the first quarter surge in long-term rates and inflation expectations, and the second quarter reversal appears to reflect a belief that U.S. growth and inflation rates may have peaked. While inflation is being taken seriously by the Fed and the markets, there is now a growing consensus that it mostly stems from transitory, pandemic-related issues.”

He says: The big story of the second quarter of 2021 was the sharp reversal in the trend of both long-term U.S. Treasury rates as well as U.S. inflation expectations, which both fell.

Long-term rates fell 25 bps during the second quarter, in sharp contrast to their 81 bps rise during the first quarter, while inflation expectations (as measured by the U.S. Treasury breakeven rate), cooled from their May high of 2.54% to 2.32% on June 30.

So even if the retracing downward didn’t match the first quarter surge, it is useful to consider why we saw the reversal.

Generally, the economic expansion remained strong, though the delta declined with the latest upticks in GDP having not matched the initial prints that reflected the change from the depths of the pandemic-induced slowdown. Inflation prints continued to trend higher, but, as mentioned, expectations waned.

The growth story is certainly intact in the credit markets, where spreads remain at or near all-time historical tight levels, across the quality spectrum. For example, investment-grade corporate-bond yields are negative in real terms. As of June 30, the spread on the ICE BofAML U.S. High-Yield Index was 3.04 percentage points — its lowest level since 2007.

However, I don’t believe that long-term rates necessarily reflect a change in the “real” economy. Rather, I think it is a case of the market getting ahead of itself in pushing Treasury rates and inflation expectations up so fast in the first quarter. Keep in mind that rates were falling through most of the second quarter, even before the June 16 meeting of the U.S. Federal Reserve, when it adopted a surprisingly (but still modestly) more hawkish stance.

A new Fed consensus The Fed’s consensus projection for new rate hikes moved up to 2023, compared with March when no FOMC members predicted hikes that early. The Fed’s traditional “dot plot” for 2022 also showed a hawkish shift, with seven members predicting a hike by then, compared with four in March (though these are not median projections).

The Fed also advanced from the phrase “talking about talking about tapering” to simply “talking about tapering.” Two days after the meeting, St. Louis Fed Bank President James Bullard indicated the first rate hike could come as soon as late next year. It is still very much an open question how the newly hawkish talk correlates with the Fed’s average inflation targeting (AIT) policy, which it announced almost a year ago. Under AIT, the Fed has said it is willing to let inflation run “hotter” than its long-term goal of 2% for a period, taking into account the years in which it has remained under that target.

I think the market is still trying to gauge exactly how much the Fed will let inflation run above 2 percent in order to meet both its AIT framework as well as other policy objectives. The June 16 meeting seemed to potentially indicate that the current answer is, “not much.”

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As Chief Investment Officer, Fixed Income, Mr. Stein will be responsible for overseeing the management of investment strategies for EVM and its affiliate Calvert Research and Management (Calvert) across the income markets, including floating-rate loans, high-yield bonds, municipal bonds, emerging market debt, mortgage-backed and asset-backed securities, investment-grade corporate and government bonds, and multi-asset income solutions for individual and institutional clients.  As of July 31, 2020, assets under management in EVM and Calvert income strategies totaled $90.2 billion.

Mr. Stein has served as Co-Director of Global Income Investments with Michael A. Cirami, CFA, since 2012.  Mr. Cirami will become sole Director of Global Income Investments, in which capacity he will continue to lead EVM’s Global Income group, reporting to Mr. Stein.

“I am pleased to announce Eric’s promotion to Chief Investment Officer, Fixed Income,” said Mr. Faust. “Under his leadership, I am confident that EVM’s income investment teams will continue the commitment to investment excellence and outstanding client service that has been their hallmark throughout Payson’s long tenure.”

Addressing Mr. Cirami’s elevation to sole Director of Global Income Investments, Mr. Stein commented, “Mike is an incredibly talented investor and passionate business builder whose leadership and vision have been instrumental to our success in global income investing.  I look forward to continuing to work closely with Mike in our new roles.”

Mr. Stein joined EVM in 2002, serving as a trading associate and research associate in the Global Income group before leaving to attend business school in 2005.  He rejoined EVM’s Global Income group in 2008 as a research analyst from the Federal Reserve Bank of New York, where he worked on the Markets Desk. He has additional experience at Citigroup Alternative Investments.  Mr. Stein earned a B.S., cum laude, from Boston University and an MBA, with honors, from the University of Chicago Booth School of Business. He is a CFA charterholder, term member of the Council on Foreign Relations and member of the CFA Society Boston, Boston Committee on Foreign Relations, Boston Economic Club, Enterprise Club and AEI Boston Council.

Mr. Cirami joined EVM in 2003 and started his career in the investment management industry in 1998. Before joining EVM, he worked at State Street Bank and BT&T Asset Management. Mr. Cirami earned a B.S., cum laude, from Mary Washington College and an MBA with honors from the William E. Simon School at the University of Rochester. He also studied at WHU Otto Beisheim School of Management in Koblenz, Germany. He is a CFA charterholder and member of the CFA Society Boston, Boston Committee on Foreign Relations and the Ludwig von Mises Institute.

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Eric Stein

In the US presidential election, the polls have tightened over the past several weeks and market-implied betting probabilities have started to close.

Eric Stein, Co-Director of Global Income at Eaton Vance Management notes: “At this point, however, I think Joe Biden should still be considered the frontrunner. Recent momentum for President Trump depends heavily on what happens with the economy and the coronavirus. Only a month ago, large majorities of potential US voters expressed fear about how much the pandemic seemed to be accelerating, which lowered the probability of Trump’s re-election. Now, with the number of new infections slowing somewhat in the US, Trump’s prospect of winning — implied by either the polls or the market — appears to be going up.”

He adds: “Much has been said about the economic impacts of President Trump getting re-elected, Biden winning but the Republicans keeping the Senate, or Biden winning with a clean Democratic sweep of Congress. Certainly, there would be a big impact on tax rates and regulatory policy depending on these outcomes.

“I think it’s also important geopolitically whether Trump or Biden wins. Clearly, the Trump administration has shifted the narrative on China — essentially the only bipartisan issue in Washington where everyone has been trying to out hawk each other.

“If Biden gets elected, I don’t expect him to go soft on China as Trump has claimed, but rather to be far more hawkish than he was as Vice President in the Obama administration.

“That being said, I anticipate that Biden’s approach would be different — far more multilateral with US allies in Asia, and with Europe more in the fold than it has been under President Trump.

“So I think the geopolitical ramifications of the US election should not underestimated and could even be more important than the impacts from a domestic tax and regulatory policy perspective,” Stein says.

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Michael A. Cirami, CFA, and Eric Stein, Co-Directors of Global Income for Eaton Vance Management say: “In particular, investors have been paying more attention to fundamentals and there has been a notable performance dispersion between the debt of different countries.

“That said, we do not believe markets have necessarily seen their floors, as the adverse economic ramifications from virus prevention policies will be severe and vary by country, and it’s not clear this has been fully discounted at this time.

“Despite the unsettled conditions, we believe that a market that differentiates based on fundamentals is a good environment for us, given our focus on individual country-level policy and economic fundamentals.

“We have begun to see the ratings agencies downgrade countries as they’ve been doing with corporates; for example, Moody’s did so with South Africa on March 27, a country on which we’ve long had a negative view.

“Also of note, Oman was downgraded by Standard & Poor’s last week, firmly into “junk” status. Moody’s made a similar move about three weeks ago. Downgrades of many other sovereign credits are likely to follow in the not-too-distant future.

“Much more important than downgrades — which are not part of our investment process — is the fact that the occurrence of sovereign restructurings will likely increase. Countries we have already noted as having sought restructuring include Argentina, Lebanon, Zambia and Ecuador. It also appears that Angola, Sri Lanka and Oman, among others, may be heading in that direction.

“While we continue to favour maintaining low levels of risk and high levels of liquidity, as noted, we have begun to “nibble” at positions where we believe market volatility has pushed valuations substantially below what we believe are fair. This has primarily been within the hard-currency sovereign credit space, where the proverbial baby has been thrown out with the bath water. Some of the actions we had taken leading up to and into March have begun to bear fruit, including some short positions we added and some long positions we trimmed.

“What we are watching?  The sell-off has given us the opportunity to look for investments in keeping with the higher-quality macroeconomic developments we are following. We encourage investors to turn attention from the shocking impact of the first wave of COVID-19 infections, and consider the lasting effect that this will have on global trade patterns, consumer preferences and the economic reform momentum of countries.

“While its assets are not particularly compelling, South Korea has been an excellent example of the kind of policy response we have been looking for. It was one of the first countries to scale up testing and isolation of patients. It is still tightening its controls even as new cases slow to under 50 per day.

“A final word. Given the huge leg down in core bond yields around the world, the aggressive actions taken across the board by the Fed and other central banks, and the heightened levels of volatility across traditional markets, we see a clear scenario emerging on the back end of this: Investors will be seeking out alternative sources of income and total return from around the world.”

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The markets are digesting the midterm-election results.

The American midterm elections didn’t trigger any high-level surprises in Congress with the Senate remaining in Republican control and the House flipping Democrat, as expected.

Now, investors can focus their political attention on the 2020 presidential race and what should be a wide-open field of Democratic candidates says Eric Stein, Co-Director of Global Income, Eaton Vance, a leading global asset manager.

Mr Stein says: “Of course, it seems like presidential campaigning cycles are starting earlier and earlier. For example, President Donald Trump formally announced his campaign in June 2015. And the summer of 2015 featured Republican debates with more candidates than could fit on one stage. I would expect that it won’t take too long for the focus to be on the 2020 presidential campaign, and you may well see a very large number of candidates on the Democratic side, as you did with the Republicans in 2016.

“While there is much talk about divided government or gridlock — and those words have negative connotations – a divided government is nothing new, and markets typically do quite well in that environment.

“The immediate reaction in markets Wednesday is positive, with stocks and other risk assets rallying.^[1] The U.S. dollar is broadly weaker and the U.S. Treasury market is flattening, with the long end of the curve outperforming. This move in the Treasury market shows that market had some concern that if the Republicans defied the odds and kept the House, that the deficit could be even wider, which would have weighed on the bond market.

“In fact, when Nate Silver’s website 538 as well as some betting markets briefly increased the odds that the Republicans would keep the House last night, the dollar rallied and U.S. Treasury yields rose a few basis points. That price action was reversed following confirmation of the expected outcome of the Democrats regaining control for the House.

“With the Democrats taking the House, there is no chance of a further tax cut. However, one potential area of common ground for President Trump and House Democrats would be on infrastructure, and President Trump said as much during his press conference today. If a major infrastructure bill were to pass, this could also weigh on the deficit and further pressure the bond market; although that is not how the Treasury market is reacting today.

“While it will be difficult to get much legislation other than a potential infrastructure package passed with a divided Congress, the Republicans should be able to easily confirm both judges and cabinet appointments given their likely enhanced majority in the Senate. In addition, markets will continue to be very focused on developments in the trade war/tariff front, as well as the potential political headlines from either the Mueller investigation or any investigations that the new Democrat majority in the House choose to pursue on the administration.

“Bottom line: The markets are digesting the midterm-election results, and so far the reaction has been favorable for risk assets. In addition to the potential political developments that investors will focus on listed above, the 2020 presidential election campaign will be here before we know it.”

——-

[1] Risk asset is a term broadly used to describe any asset that is not a high-quality government bond.

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Specifically, we are watching the ongoing stalemate over Catalonia’s independence and the populist movement gaining momentum in Italy.

Investors were able to put politics to the back of the mind over the summer following the euphoria after Emmanuel Macron defeated Marine Le Pen in the French presidential election. Additionally, markets focused on the economic strength in the Eurozone. But now, politics are back to the forefront.

In Spain, the Catalan president has decided to suspend the declaration of independence following the referendum vote on October 1, which only extends the period of uncertainty. Eventually, the dispute will be resolved with the likely outcome either the takeover of the Catalan government by the national government, or additional autonomy for the region.

While it will not likely result in independence right now, underlying tensions will likely remain.

In Italy, the strong support for the 5 Star Movement could potentially lead to higher political risk premiums in Italian assets, but it is unlikely that the party comes to power. A weak coalition is a high possibility with polls showing a fragmented landscape and a continuation of more of the same can be expected.

These two situations may create volatility in the near term, but both economies will likely be supported by the recovery in the Eurozone. An additional factor to watch will be ECB policy as it seems that the market is underpricing the impact that a reduction in purchases will have on the region.

The near-term uncertainty, combined with this shift from traditional politics that we are seeing across Europe, has made us more cautious on the outlook for the periphery.

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Trump may not get its way on pro-growth initiatives.

The markets showed a clear pattern in the weeks following President Donald Trump’s election victory: stocks rallied, Treasury yields rose and the U.S. dollar strengthened. Some investors and commentators called it the ‘Trump trade’.

However, according to Eric Stein, Co-Director of Global Income at Eaton Vance, a leading global asset manager: “Fast forwarding to today, although equity markets seem to hit new highs daily, yields on the U.S. Treasuries have fallen this year and the dollar has weakened recently. Some of this may be doubts that the Trump administration will not get its way on pro-growth initiatives such as tax cuts and infrastructure spending.”

Mr Stein says “Although there are a wide range of potential outcomes, we still believe the U.S Treasury bond and currency markets may have gotten too pessimistic on the potential for tax cuts and infrastructure spending.

“We would also urge investors to maintain a long-term view and not get caught up too much in the daily drama and short-term noise in Washington,” he says.

He outlines the reasons why ‘Trump Trade’ has faltered.

“Some of the recent decline in Treasury yields, inflation expectations, and the dollar can be attributed to U.S. data that has been somewhat weaker than expected. However, the unwinding of the Trump trade has also been driven by doubts the administration will able to make good on its policy changes to promote economic growth. For example, there are questions over health-care reform and the chances of an overhaul of the tax code.
“At the same time, it’s easy for investors to get distracted by the political fireworks in Washington, such as this week’s testimony from former FBI Director James Comey. I was reminded of this recently. A few weeks ago right after Comey was fired, I asked participants at our Fixed Income Group morning meeting what probability they assigned to Trump not serving his full four-year term. It was interesting what a passionate and interesting discussion ensued following my question, with very different answers across the people attending the meeting.”

He says “Don’t bet against a Trump comeback.”

“While many investors are now completely discounting the possibility of any accomplishments from the administration, I wouldn’t count Trump out.
“President Trump is certainly a polarizing figure who makes it tough for many to have an unemotional conversation about him. Whether you like him or dislike him, any neutral observer would have to admit that he has shown the ability to come back from many personal and professional setbacks in his life. That’s one reason why Treasury and currency markets may be too pessimistic on the potential for reforms right now.

“The easiest reforms for the administration would be in the area of regulation because that is where President Trump is far less dependent on the Congressional legislative process. If he can start with some easy wins in the area of regulation, maybe there will be the potential for some progress on the tax and infrastructure fronts as well.”

Mr Stein says “Investors should always be on the lookout for both sides of the distribution of market and economic outcomes when assessing President Trump (pro-growth reforms vs. Twitter spats and self-created distractions). When markets get too focused on only one side, they may start to turn the other way.”

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“Inauguration Day is finally here and it could be a whole new world for investors after January 20th…”5

“May you live in interesting times” goes the Chinese curse. It also pretty much sums up many investors’ mindset as they await the inauguration of Donald Trump says Eric Stein, Co-Director of Global Income, Eaton Vance.

“Inauguration Day is finally here and it could be a whole new world for investors after January 20th. With a new administration in the White House, and Brexit and more key elections looming in Europe, investors should be prepared for more volatility and political uncertainty.” he adds.

“The main takeaway of a Trump presidency is the distribution of expected outcomes has widened dramatically. However, in the initial post-election period, markets focused more on the larger right tail of the distribution and reaction was punctuated by rallying equities, a stronger U.S. dollar and rising Treasury yields.

“Now, equity markets have been in a bit of holding pattern recently after their post-election rally, while Treasury yields and the U.S. dollar have fallen somewhat from post-election highs.

“Yet the big question is how markets will react after Trump takes the Oath of Office as the 45th U.S. president, and investors start to get more details on his administration’s policies and agenda.

What tone will Trump take in his inauguration speech on Friday?

“In his November 9 acceptance speech, Trump struck a magnanimous tone. He spoke of uniting the country and even congratulated Hillary Clinton on a hard-fought campaign. Trump also asked Americans to come together as a united people and reached out to those who didn’t support him. Those sentiments seemed to calm markets and focus investors on Trump’s pro-growth policies, and away from negative issues like protectionism and building walls.

To me, that tone was a very important driver in the markets’ initial post-reaction, says Stein.

“However, some of the market momentum has petered out a bit lately. The Dow Jones Industrial Average has stalled near the much-talked-about but not economically significant 20,000 mark, while the CBOE Volatility Index (VIX) has perked up a little after falling to a two-year low.

Uncertainty over Trump’s policies could be a factor.

“However, I think Trump’s behavior during the transition period is the main driver of the recent market action. Certainly, he has lashed out at the media, Clinton, intelligence agencies and others on Twitter and during press conferences. In short, he has been acting more like a candidate than a president.

“Markets should not underestimate the chance for a transformational positive economic environment should Trump combine fiscal and regulatory reform along with a more positive tone.

But nor should they discount potential downside risks should Trump continue with his negative tone and focus more on trade protectionism than on pro-growth reforms.”

Stein notes “Both outcomes are very possible, but I think it’s almost as important to watch tone and messaging as it is to watch the specifics of policy proposals.”

“The inauguration speech is obviously an opportunity for Trump to act more presidential, and investors will be watching and listening closely. They will also focus on the communication style after the inauguration, and any details on what Trump plans to tackle first and how.

“Markets have been taking a wait-and-see attitude, but that may soon change. And that likely means more volatility as we get more details on potential tax cuts, regulatory changes, infrastructure spending and other policies,” he concludes.

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