FW: The US Fixed Income Weekly: Fixed Income Strategy

BofA Merrill Lynch Global Research

A Fixed Income Research Report

Friday, 31 October 2014

The US Fixed Income Weekly

Fixed Income Strategy

·         US GDP rose a solid 3.5% in 3Q and the Fed ended QE3 as expected. Market attention will now shift to the hiking cycle. ·         We still see a "considerable time" before rate hikes, particularly since the Fed is missing its inflation forecast. ·         Overweight securitized and HY credit, neutral on the agency MBS basis, tactically short HG, and underweight Treasuries.

Overview  US GDP rose a solid 3.5% in 3Q and the Fed ended QE3 as expected. The market will now shift attention to the hiking cycle. We still see a "considerable time" before rate hikes, particularly since the Fed is missing its inflation forecast. Overall, we remain underweight in Treasuries, overweight in securitized and HY credit, neutral on the agency MBS basis, and turn tactically short in HG.  Special Topic - The QE is Dead, Long Live the E!  Our post-QE worlds... Deflationary Booms in the US, UK and many metropolitan "1% enclaves". Deflationary Busts in Europe & Japan, and a Race to Reform in Emerging Markets. Ironically QE ends with investors pricing in deflation rather than inflation.  Economics - Inflation's flat tire keeps Fed stranded  We now expect no pick-up in inflation over the next year. As a result, we have moved the first rate hike next year to September from June. We are making two notable forecast changes this week, lowering our inflation forecast and delaying the first Fed hike to September.  Rates - Life after QE3  After QE3, attention should shift to the hiking cycle, especially with the market continuing to price the front end well below the Fed's projections. We believe that risk premium in the front end should be higher with a data dependent Fed. Further, demand for the front end is lower and positioning is cleaner. We recommend front end shorts and flatteners over the near term.  Securitized Products - Curve flattens; purchase applications, homeownership and home price growth down  The curve flattened further this week as the Fed's inevitable tightening was signaled. More declines in the homeownership rate, purchase mortgage applications and home price growth were reported. Relatively stable securitized products performance this week provided more validation of our constructive thesis.  Credit - Goodbye QE, hello QE  With interest rate risk back following the FOMC statement we have turned our tactical long into a tactical short. In 2015 we look for a 11% decline in high grade new issue supply to $950bn, led by industrials.  EM Sovereigns - Improving sentiment supports EM  The collapse in oil prices presents some risks to certain EXD. However, we tactically moved Venezuela to OW due to distressed prices but remain UW Russia.   Municipals - Midterms and Munis  The municipal market got the trifecta this month with surging GDP, falling unemployment, and the apparent end of the Detroit bankruptcy. The currently surging GDP should lead to large increases in state sales taxes now, and personal income taxes next year. For the week, municipals generally traded with Treasuries in an active and volatile market. The ten year AAA Muni ratios to Treasuries fell slightly over the week from 88.9% last Friday to 88.5% on Thursday.