Navigating the Economic Landscape: Third Quarter Total Return Outlook

With the economic landscape dominated by the Federal Reserve’s tightening program, there has been a lot of speculation about how this would impact the economy. Despite some trepidation, the economy has held up remarkably well. However, as we look ahead, it’s important to note that with two more likely hikes in 2023, the risk of a slowdown remains elevated.

Navigating the Economic Landscape: Third Quarter Total Return Outlook

Take a Hike:

In retrospect, the first quarter of the year presented a strong performance for the investment grade bond market. In stark contrast, the second quarter mostly marked time. Treasury yields were on the rise as a result of some contagion following the bank failures in the first quarter, coupled with weakness in the commercial real estate sector. Smaller regional banks were in the crossfire, facing considerable setbacks due to their large exposure to commercial real estate.

Steady As She Goes:

Despite these challenges, the Federal Reserve remains steadfast, maintaining a steady course amidst the volatility it has largely stirred up. And it seems to be working – the risk appetite has notably improved in recent weeks, except in the commercial real estate sector. This points towards a narrative that any slowdown the economy may face will be relatively mild – if it occurs at all.

The end of June saw corporate spreads near their tightest levels of the year, a testament to the robust performance of equities. Mortgage-backed securities (MBS) also saw an upswing as volatility ebbed, although they continue to be susceptible to a rise in rates as was evident in May when nominal spreads reached their widest levels in over a decade.

Inflation: The Elephant in the Room

Inflation is a topic that is impossible to ignore in these discussions. The headline inflation is indeed declining, but not at a pace that pleases the Fed. Our preferred inflation measure, the Underlying Inflation Gauge, is declining sharply towards 3%, and seems to be on track to hit 2% by the fall. The real conundrum at this juncture is whether the significant growth in M2 money supply during the pandemic (the “printing money days”) leads to a higher forward inflation path that proves more difficult for the Fed to control. Only time can answer this question.

Looking Ahead:

Moving forward, we maintain a relatively positive stance on duration, considering yield levels remain appealing for long-term investment. We continue to favor Mortgage-backed securities (MBS) over investment grade corporates due to the former’s relatively wide spread levels.

Despite the current strength of the economy, it has yet to demonstrate an ability to withstand this level of the fed funds target rate in this century.

In conclusion, the Federal Reserve’s tightening program has so far been successful, but the real test lies in whether the economy can withstand further rate hikes. The resilience of the economy, despite the 500-basis-point increase in rates over the past 18 months, paints a promising picture. However, the looming threat of an economic slowdown and the unresolved question of inflation create an air of uncertainty as we look to the future.

As always, we appreciate your trust in our management. We remain dedicated to focusing on the areas of the market that we believe can yield attractive risk-adjusted returns over time. Amid these complex economic winds, our goal remains to steer the course and provide insightful and strategic perspectives on the total return outlook.

Author:Com21.com,This article is an original creation by Com21.com. If you wish to repost or share, please include an attribution to the source and provide a link to the original article.Post Link:https://www.com21.com/navigating-the-economic-landscape-third-quarter-total-return-outlook.html

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