Bonds Commentary

Yields To Trend Higher Into Year-End?

November 2019

With relatively stable interest rates and a slight compression in credit spreads, October was a “clip your coupon” type month across the fixed income landscape. For the month, the Bloomberg Barclays U.S. Corporate bond index was the standout performer, rising 0.6%. While slight, the October return on the investment-grade corporate bond index more than doubled the return of the high yield corporate bond index, continuing the year-to-date trend of higher quality credit outperformance. Through October, the investment-grade corporate index had generated a 13.8% total return year-to-date, outpacing the still respectable 11.7 % total return posted by the high yield corporate index and the 8.8% total return generated by the broader Bloomberg Barclays U.S. Aggregate bond index. The broader index’s relative underperformance was primarily due to Treasury and Agency securities, where returns lagged that of corporate credit.

From a tactical perspective, we re-allocated a portion of our international fixed income exposure into domestic investment-grade core bonds at the end of October. This move was not centered around a bearish outlook on all international debt, but rather more attractive risk, or volatility-adjusted return expectations on structured products in the U.S. Partially driving this decision is the limited opportunity set available in international developed bonds, as the decline in global interest rates has left many sovereign bonds issued by G10 countries with a negative yield. On a dollar-hedged basis, many of these bonds can still churn out a positive yield, but as the FOMC has lowered the Fed funds rate, the strengthening dollar tailwind that boosted returns for U.S.-based investors has become less enticing. Select emerging market bonds still offer value and sought-after yield, but trade tensions and sluggish global growth should not be ignored, as they can have long-term ramifications. This move increases our exposure to AAA-rated bonds, providing cushion against equity volatility, while reducing portfolio yield just a few basis points in the process.

Diversification remains paramount for fixed income investors, as the stars may be aligning for the recent bounce in global bond yields to continue through year-end. If European data is indeed bottoming, global rates should move higher, pulling U.S. rates higher in the process. To provide some protection on a relative basis against a potential rise in rates, we continue to maintain a duration profile below that of our benchmark. With tight credit spreads, low U.S. Treasury yields, and high interest rate sensitivity, we remain concerned that investors will be tempted to reach for yield to generate income. At present, risk -adjusted returns appear paltry across the fixed income landscape, leading us to focus on the preservation and protection of capital in the current environment.

Source: Bloomberg, Factset


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