Fixed Income Strategist - February Update (UBS)
This report has been prepared by UBS Financial Services Inc., an affiliate of UBS AG (UBS).
* Outlook: The Fed on hold:
The key question facing bond investors is whether the January rate hike will be the Fed's last. Our economics team believes this is the case. However, we look for bond yields to be biased slightly higher this month on market expectations for more tightening.
* Duration: A neutral allocation:
Above-trend economic growth, slightly higher inflation, and the potential for additional Fed tightening are likely to bias Treasury yields modestly higher this quarter, before yields likely fall later in the year. Given our view that Treasury yields will remain range-bound this year, we maintain a neutral duration weighting.
* Yield curve: Inversion to persist:
We believe both structural and seasonal factors could deepen the inversion of the 10s/2s term spread in the near term. The shift in recent years in the Treasury borrowing mix to shorter maturities is supportive of a flatter yield curve. In addition, there is strong demand for long duration assets by pension managers and a seasonal tendency for the curve to flatten in February.
* Sectors: Changing agency and TIPS weightings:
We increase our weighting on agencies to a modest overweight and lower our weighting on TIPS to market weight. We recommend a modest overweight on mortgages and municipals and underweight on credit, all unchanged.
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