While the outlook for developed global economies is by no means rosy, investors have been so pessimistic and defensively positioned for so long that the absence of another crisis could be enough to coax cautious investors back into the markets. There is still an extraordinary amount of money on the sidelines or in safe-haven Treasuries, and we believe these investors may be more attuned to the opportunity costs of inaction in 2013.
With respect to monetary policy, the Federal Reserve launched the much-anticipated “QE3” in September, a bond-buying program authorized to purchase up to $40 billion of agency mortgage-backed securities per month, a number which represents essentially the entire supply of newly originated mortgage securities. Not long after, in December, the Fed replaced the expiring “Operation Twist” with an additional unlimited round of easing, targeting up to $45 billion worth of intermediate- and long-term Treasuries per month.
The biggest surprise from the Fed, we believe, was the introduction of specific benchmarks into its most recent statement. Past statements had suggested the Fed’s intent to maintain its accommodative stance into 2015, if necessary; that language has since been modified to state that the current easy-money environment will continue as long as unemployment remains above 6.5%, one- to two-year inflation projections remain no more than a half percentage point above the 2% longer-run goal, and longer-term inflation expectations continue to be “well anchored.” These kinds of explicit targets are rare coming from the Fed, and we believe it suggests something about the Fed’s desire to offer a degree of clarity to investors. Its four-year expansionary monetary policy has been unparalleled in scope and size, and benchmarking its policy to these specific boundaries helps provide some welcome insight as to when the Fed is likely to begin shifting to a more neutral monetary stance.
Against this backdrop, we continue to target opportunities in corporate and mortgage credit, with smaller allocations to emerging markets and commercial mortgage-backed securities. As we have said for some time, extraordinary levels of government intervention have been keeping interest rates across the fixed-income markets artificially low, and any strategy that relies on today’s historically low interest rates declining further to generate returns is a risky proposition. For that reason, we have continued to keep a low-duration stance in our portfolios, allowing other factors to drive the performance of our funds.