The bond market can provide valuable insights into where the equity markets may be more broadly headed. With credit spreads remaining historically tight, the bond market is signaling a rare degree of optimism. This positivity is surprising given the uncertainty associated with looming political fights over the debt ceiling, tax reform (or cuts), the unwinding of the Federal Reserve’s balance sheet, and heightened geopolitical tensions across the globe. Not everyone is optimistic, however. Many are rejecting the signals from the bond market and are predicting some form of a correction though it is improbable to pinpoint the timing and severity of a pullback, or if one occurs at all.

While markets may not yet be reflecting the risks associated with these potential upcoming political fights, markets may get spooked as we get closer to the deadlines. There are some signs this is already happening in the treasury market: T-bills maturing around the expected dates of various political showdowns are trading at higher levels than longer-dated T-bills, indicating that the market is preparing for a risk-off environment during these political fights.

Yet with credit spreads tightening this year, lower quality bonds like High Yield and Preferreds, have been among the best performers:

In addition, the mild decrease in 10 year treasury yields has favored fixed rate instruments over floating rate.

 

 

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