• Investors reduced risk in April by selling equities (S&P 500 -.75% MoM) and buying bonds, as more than $30B likely flowed into bond mutual funds over the month.
• 10-year Treasury yields fell by 30bps in April as the curve continued its significant flattening pattern. The 2s/10s spread curve flattened to 152bps over the last couple of days from a near-term high of 200bps on March 16th. 2- and 10-year Treasuries ended the month yielding 0.26% and 1.91%, respectively.
• A risk-off attitude grew in the markets as European problems intensified. Anti-austerity measures toppled several governments around the continent, with the Dutch government resigning due to failure to implement 12B euro in cuts, while Sarkozy lost an election to leftist Hollande in France, and Greece drifted further towards a Eurozone exit.
• April nonfarm payrolls printed at 115K, or significantly lower than market expectations of 160K. At only half of the prior 3 month average (230K), it could prove the start of a sustained period of substantially weaker jobs growth similar to both 2010 and 2011.
• The unemployment rate edged down to a three-year low of 8.1%, with help from the participation rate. It slipped from 63.8% to 63.6% last month, constituting a 30-year low in this key component of the unemployment rate.
• Several manufacturing gauges lost strength in April, highlighted by the Empire Manufacturing report falling to 6.56, the worst level of 2012.
• Core inflation has held steady at relatively mild levels, only slightly above the Fed's 2% target. Alternatively, headline CPI has steadily dropped over the past few months. With commodity prices down over the past three months, we expect inflation to moderate further. Should the dollar sustain its recent strength, inflationary pressures should dissipate as prices from non-energy imports drop.
• First-quarter GDP growth came in at a disappointing 2.2% versus market expectations of 2.5%. An unexpected decline in defense spending reduced the print by 0.4%. The wider March US trade deficit points to a sharp downward revision in first-quarter GDP growth.
• Alternatively, consumption unexpectedly became the primary driver of GDP, as it jumped by a stronger than anticipated 2.9%. Since May 2011, real disposable personal income has increased at a pace of about 0.8%, while spending has increased at more than twice the rate or 1.9%. Given the weakness in personal income and the unsustainable over-spending, the strength in consumption may wane over the next few quarters.
• States ranging from North Dakota to Texas, and many areas in between, have benefited from both higher oil production and higher agricultural prices. We’ll review the states that have benefited and look to increase municipal bond investments in these areas that are likely to continue to benefit from stronger growth due to these commodities.
• While continuing to recommend seasoned premium mortgages, we suggest that investors consider adding GNMA project loans as they remain an overlooked segment of the MBS market that offers relative value opportunities.
• As call volume for agencies remained high and volatility low, callable yield premiums compressed significantly. In fact, yields offered by new issue step ups now fall right in line with duration matched callable agencies, allowing investors to pick up the defensive characteristics of steps without sacrificing yield.