Seeing Red

February 2021

While admittedly early in the new year, January had investors hiding out in some of the ‘safest’ pockets of the fixed income market seeing red (negative returns). The rollout of COVID-19 vaccines on a broader scale allowed economic optimism to again creep in, leading to increased chatter of the Fed potentially tapering bond purchases at some point in 2021, much earlier than market participants had been anticipating. Yields on long dated U.S. Treasury bonds moved sharply higher early in the month but stabilized into month-end after Chair Jerome Powell of the Federal Open Market Committee (FOMC) again reiterated that the Committee isn’t even thinking about thinking about tinkering with the Fed funds rate or the pace of bond purchases at the present time. Ultimately, the 10-year U.S. Treasury yield rose from 0.92% on December 31 to 1.09% on January 31, while the 30-year yield ended the month 20 basis points higher at 1.85%. The Bloomberg Barclays U.S. Treasury index, which carries a duration of just over 7 years, ended the month lower by just shy of 1%.

The Bloomberg Barclays U.S. Aggregate Bond index, the industry standard benchmark for broad exposure to investment-grade fixed income, fell 0.7% during January, pulled lower as prices of Treasuries as well as investment-grade (IG) corporate bonds fell. While the Bloomberg Barclays Corporate index, which is made up entirely of investment-grade corporates, fell 1.2% on the month, the Bloomberg Barclays U.S. High Yield index ended the month higher by 0.3%. Investors have begun to balk at sub-2% yields in IG corporates and are opting to shift some exposure into high yield, a trade that would have been additive in January. With the FOMC reaffirming its intention to continue purchasing $120BN of Treasuries and mortgage-backed securities (MBS) each month for the foreseeable future, investors remain convinced that they have implied consent from the Fed to continue taking additional credit risk, and given low yields across the board, have few viable alternatives to generate income outside of corporate bonds. We expect this backdrop to remain in place and supportive of credit markets, broadly speaking, over the balance of ‘21, with sell-offs shallow and short-lived.

The 10-year German bund yield was showing signs of trying to break out to the upside in early February, moving from -0.57% to -0.45% in less than two weeks’ time. While this may appear to be a small and meaningless move on its surface, the 10-year bund yield had encountered resistance at -0.46% twice in recent months, once in October and again in early January. A breakout above that level could signal a meaningful trend change and could be a positive early sign of things to come for the European economy in 2021 and could pull U.S. Treasury yields higher in the process. Another potential near-term driver of higher Treasury yields could be the removal of Eurozone lockdowns sooner than expected, easing fears of a double-dip recession on the continent which have kept a lid on Eurozone sovereign yields.

We remain positive on investment-grade corporate bonds and U.S. dollar denominated emerging market debt relative to Treasuries, while maintaining a neutral stance on high yield corporates. We’re less constructive on agency mortgage -backed securities than we have been over recent years and these instruments could be sources of funds over coming months. We remain underweight Treasuries and maintain a duration profile below that of the Bloomberg Barclays Agg, but as economic optimism builds and long dated Treasury yields move higher, investors should be presented with opportunities to extend duration, shifting from shorter duration bonds into longer duration Treasuries as a risk, or volatility ballast within multi-asset portfolios.▲

Source: Bloomberg, Factset