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 <!--Fixed Income Q2’14: U.S. Credit Markets--> 

<p><strong>Recent Fed Announcement</strong></p><br/>

<p>FRAN RODILOSSO: U.S. interest rates and credit markets in the second quarter of 2014 set up to be somewhat challenging. The Fed in its March meeting reiterated several points. One is that monetary policy is set to remain accommodative for some time to come. A vast majority of the FOMC does not foresee any rate hikes before 2015, and a small minority even thinks that we're looking into 2016. At the same time, the Fed has indicated it's going to continue tapering, not on a preset schedule, but most likely removing $10 billion of asset purchases a month.  </p><br/>

<p>Corporate borrowers have remained relatively healthy and we're still in a low default rate environment. We did see credit fundamentals deteriorate a little bit in 2013 so we will wait to see how 2014 first quarter numbers come out. In general, companies have gotten slightly more leveraged. We've seen more deals come out with poor covenant structures but in terms of the amount of leveraged buyout issuance, M&A-related issuance, or significant defaults, we have not seen anything like we saw before the end of (or the top of) the last credit cycle.</p><br/>


<p><strong>U.S. Interest Rates and Credit Risk</strong></p><br/>

<p>RODILOSSO: If you think about U.S. interest rates, we ended 2013 with 10-year yields at around 3%.  By mid-to-late March, they were below 2.7%.  After the March Fed meeting, they went back up to about 2.75%.  I think the consensus was that risk, even in the first quarter, would be for rates to rise to 4% on the 10-year.  We still think that’s the greater risk in the market, but if you talk to most people, their perspective looking into the second quarter is that we're range-bound between 2.6 to 3%.  If that consensus holds, it will be supportive for a lot of financial markets. </p><br/>

<p>I'd like to keep in mind that even with tapering and the Fed buying fewer treasuries or mortgage securities, if that allows the interest rate curve to steepen, short-term rates will remain quite low.  It's still a highly-accommodative policy and there is still substantial of liquidity in the market. Issuers are taking advantage of lower rates, reducing their interest rate costs, pushing out their maturities, and that remains supportive of credit markets.  It's not a cycle that we can stay in forever, but for now, interest rate risk is probably still a little higher in my mind than credit risk, but that relationship may be drawing closer together.</p><br/>

<p><strong>Value in U.S. Corporates?</strong></p><br/>

<p>RODILOSSO:   I think credit markets are still healthy. Whereas a year ago when it was easier to argue that there were returns to be had by shorter-term investment-grade bonds or high-yield bonds which are less interest-rate sensitive, today’s valuations are a little richer.  Spreads did tighten last year as interest rates rose.  That simply gives you a tighter valuation as a starting point.  We haven't seen all the negative types of borrowing although in some analysts' minds we have. In my mind, we haven't seen anything close to what we saw in the 2005 to 2007 period, and that's a reason to be less concerned. There is a difference from being expensive to being in a bubble, and you could argue expensive right now.  I think it's much more difficult in the U.S. context to argue that there is a bubble in credit markets.</p><br/>

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<p><strong>IMPORTANT DISCLOSURE</strong></p><br/>


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