Bonds Commentary

Another Challenging Year Ahead

January 2022

While 2021 was a profitable year for investors in equities, it proved to be a difficult one for fixed income investors. The Bloomberg U.S. Aggregate Index (Agg), a proxy for diversified core investment-grade fixed income exposure, ended the year lower by 1.5%, the index’s first negative return year since 2013. Investment-grade (IG) corporate bonds didn’t fare much better as the Bloomberg Corporate index fell 1% as the longer duration nature of these bonds made the index more negatively impacted by rising interest rates in the belly (5 to 10-year area) of the yield curve throughout the balance of ’21. We expect the longer duration profile of the IG corporate bond index to act as a headwind in 2022 as Treasury yields across the curve move higher amid FOMC policy normalization and moderating, albeit above-trend U.S. economic growth. This backdrop leads us to favor short duration IG corporate bonds relative to short-term U.S. Treasuries as investors can clip a modestly higher coupon with minimal price risk.

Lower quality, higher yielding bonds performed well last year, evidenced by the 5.3% total return generated by the Bloomberg U.S. High Yield index. The High Yield index has a duration of just 3.8 years versus 6.8 years for the Agg and 8.6 years for the Corporate index, thus an allocation to high yield bonds is one avenue for investors to clip a higher coupon while lowering interest rate sensitivity within their portfolio in the process. However, while the 4.6% yield-to-worst (YTW) on the High Yield index holds appeal relative to the Agg’s sub-2% yield and the IG corporate index yield of 2.5%, yields on riskier corporate bonds remain paltry relative to historical levels and as the FOMC takes steps to normalize monetary policy, volatility in interest rates and wider credit spreads will likely follow. We expect true price discovery to return to the corporate bond market as the FOMC steps away from pandemic-era support, and credit risk could quickly become more appropriately priced via higher yields on corporate bonds, which would present asset allocators and active managers with a more appealing opportunity set as defaults should remain near rock-bottom levels throughout the balance of ’22.

While early in the new year, 2022 has brought with it sharply higher yields on U.S. Treasuries and European sovereign bonds. The yield on the 10-year U.S. Treasury ended the first week of the new year higher by 21 basis points, while the 10-year German bund yield closed the week 25 basis points above its December 15 close. The pace of the year-to-date move higher in global sovereign bond yields has been unsettling for fixed income investors and has contributed to losses for fixed income indices early in the new year, a hole that will be difficult to dig out of as we expect rates to continue to rise, albeit at a more gradual pace, over the balance of 2022.

While it may feel like the time to make sweeping changes to fixed income portfolios, three simple concepts – diversification is key, know what you own, and boring is often best - that served us relatively well in 2021 remain top of mind for us, and we expect few near-term shifts to our preferred positioning. Specifically, we maintain a portfolio duration below that of our benchmark to limit interest rate sensitivity as we expect U.S. Treasury yields to rise in ’22. We prefer short duration investment-grade corporate bonds relative to short-term Treasuries, maintain an allocation to lower quality high yield corporates in-line with our strategic target, and continue to bolt-on exposure to emerging market debt as a diversification tool. Stay patient and diversified as we expect more appealing relative value opportunities to be presented over coming quarters.

Source: Bloomberg, Factset


The content and any portion of this newsletter is for personal use only and may not be reprinted, sold or redistributed without the written consent of Regions Bank. Regions, the Regions logo and other Regions marks are trademarks of Regions Bank. The names and marks of other companies or their services or products may be the trademarks of their owners and are used only to identify such companies or their services or products and not to indicate endorsement or sponsorship of Regions or its services or products. The information and material contained herein is provided solely for general information purposes. Regions does not make any warranty or representation relating to the accuracy, completeness, or timeliness of any information contained in the newsletter and shall not be liable for any damages of any kind relating to such information nor as to the legal, regulatory, financial or tax implications of the matters referred herein. This material is not intended to be investment advice nor is this information intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only current as of the stated date of their issue. Regions Wealth Management is a business group within Regions Bank that provides investment, administrative and trustee services to customers of Regions Bank.

Neither Regions Bank nor Regions Institutional Services (collectively, “Regions”) are registered municipal advisors nor provide advice to municipal entities or obligated persons with respect to municipal financial products or the issuance of municipal securities (including regarding the structure, timing, terms and similar matters concerning municipal financial products or municipal securities issuances) or engage in the solicitation of municipal entities or obligated persons for such services. With respect to this presentation and any other information, materials or communications provided by Regions, (a) Regions is not recommending an action to any municipal entity or obligated person, (b) Regions is not acting as an advisor to any municipal entity or obligated person and does not owe a fiduciary duty pursuant to Section 15B of the Securities Exchange Act of 1934 to any municipal entity or obligated person with respect to such presentation, information, materials or communications, (c) Regions is acting for its own interests, and (d) you should discuss this presentation and any such other information, materials or communications with any and all internal and external advisors and experts that you deem appropriate before acting on this presentation or any such other information, materials or communications.

Employees of Regions Asset Management may have positions in securities or their derivatives that may be mentioned in this report or in their personal accounts. Additionally, affiliated companies may hold positions in the mentioned companies in their portfolios or strategies. The companies mentioned specifically are sample companies, noted for illustrative purposes only. The mention of the companies should not be construed as a recommendation to buy, hold or sell positions in your investment portfolio.

This communication is provided for educational and general marketing purposes only and should not be construed as a recommendation or suggestion as to the advisability of acquiring, holding or disposing of a particular investment, nor should it be construed as a suggestion or indication that the particular investment or investment course of action described herein is appropriate for any specific retirement investor. In providing this communication, Regions is not undertaking to provide impartial investment advice or to give advice in a fiduciary capacity.