Fixed Income Strategist: Not So August Outlook for Bonds
(UBS)- August 9 "Now that the Soft Patch is Over...
In its Fixed Income Strategist, dated August 9, 2005, UBS summarizes the following strategies
Outlook: Bond Yields Rise, as " Soft Patch" Is Over: We look for the FOMC to lift the fed funds rate target by another 75 bps to 4% by year-end in response to signs of continued strong economic activity and higher inflation expectations. As a result, yields along the back end of the curve should eventually "catch up" to the rise in bond yields that has already occurred on short maturity bonds.
Duration: Minimize Interest Rate Risk, Maturity Extension: Given our expectations for higher yields on intermediate and long maturity bonds in the months ahead, we recommend investors maintain a below-average duration weighting and underweight on the most interest rate sensitive sectors of the bond market, such as treasuries and preferred securities.
Yield Curve: Maintain Laddered Portfolio Allocation: The magnitude of yield curve flattening that has already occurred suggests limited potential for a significant further narrowing of term spreads. In addition, the flat shape of the yield curve makes the risk/return trade-off for extending duration less compelling.
Sectors: Raise TIPS Exposure; Market Weight Corporates and Agencies: Solid economic growth over the balance of the year should provide a stable environment for the credit-sensitive sectors of the market, and higher inflation expectations should prove supportive of inflation-protected securities.
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