Above all, the new year brought good news regarding a potential return to normal for economies, which largely left fixed income markets to worsen in the first quarter of 2021. The introduction of the fiscal stimulus package US $ 1.9 trillion US dollar and the ongoing deployment of the coronavirus vaccine have boosted expectations of economic growth and rising inflation, both of which have led to soaring interest rates and a steepening of the US Treasury yield curve during the quarter. Inflation in particular has scared bond investors as rising prices erode the value of coupon payments.
Rising rates caused problems for most fixed income sectors. Overall, all bond sectors except the highest yielding and less rate sensitive sold as investors sought yield and reduced their exposure to rising rates. The Bloomberg Barclays US Aggregate Bond Index, an indicator of exposure to typical US core bonds, fell 3.4% for the quarter. In the end, most Morningstar fixed income categories lost ground in the first quarter of 2021. Long government funds followed the pack with an average decline of 12.8%, while floating rate bank loan funds led the way with an average gain of 1.5%.
The Fed is holding on
While investors worried about the prospect of higher inflation, the Federal Reserve remained indifferent, indicating that it believed the rate hike was orderly and that high inflation was likely transient. Although the Fed has effectively raised its projections for economic growth, the U.S. central bank has maintained its program of purchasing $ 120 billion in treasury bills and agency mortgage-backed securities per month and continued to ‘indicate that the fed funds rate would likely stay close to zero through the end of 2023.
Against this backdrop, the yield curve steepened as short-term rates were anchored by Fed policy, while long-term rates rose as public debt lost its luster. The 10-year rate jumped 81 basis points to 1.74% in the quarter. In February, disappointing demand for 7-year US Treasury bills further fueled the liquidation of public debt. Given its high sensitivity to interest rates, the Bloomberg Barclays Long Treasury Index plunged 13.5% in the first quarter, while the Bloomberg Barclays US Treasury 1-3 Year Index declined slightly by 0. , 1%. Meanwhile, short-term government debt offering protection against inflation has fared even better; the Bloomberg Barclays US 0-5 Year TIPS Index rose 1.1%.
Funds with a shorter duration, a measure of interest rate sensitivity or a focus on inflation protection were among the top performing high-quality fixed income strategies during the quarter. Limited time BBH (BBBIX) and Pimco 1-5 years US TIPS ETF (STPZ) gained 0.5% and 1.1%, respectively, and were among the best performers in their respective categories of ultra-short bonds and inflation-protected bonds.
In the more rate-sensitive core and core intermediate bond categories, strategies that had high exposure to agency MBSs resisted liquidation better, in part due to the shorter duration profile of MBSs. JPMorgan Mortgage Backed Securities (OMBIX) and DoubleLine Total Return Bond (DBLTX) were two of those deals, losing 0.4% and 1.5% respectively, a smaller drop than most peers in their respective main and main-plus peer groups.
Investors stretch for yield
Investors continued to move into the riskier areas of the credit markets in their quest for yield, reinforcing the trend in the second half of 2020. In light of demand for yield, publicly traded private issuers rushed to profit as conditions remain favorable, flooding the market with new issues in a record quarter for high yield sales. At the same time, energy bonds were boosted by higher oil prices during the quarter, given growing economic optimism. (Crude oil [WTI] rose 22.2% in the quarter to close at $ 59 a barrel.)
Credit quality largely dictated business performance during the quarter. The Bloomberg Barclays US Corporate High Yield Index gained 0.9%, while the Bloomberg Barclays US Investment Grade Corporate Index fell 4.7% over the period. As the Bloomberg Barclays US High Yield Ca to D Index climbed 14.6%, aggressive approaches to credit risk were generally rewarded during the quarter. High Income Advantage Fidelity Advisor (FAHCX) gained 4.2% in the first quarter, outperforming most of its peers in its high yield bond category, thanks to its high stake in lower-rated bonds as well as its roughly 20% allocation to equities .
Convertible bonds, hybrid securities combining the characteristics of debt and equities, also benefited from the continued rise in equities. MainStay MacKay Convertible (MCNVX) rose 3.1% and landed in the top quintile of the convertible category over the period. Meanwhile, bank loans have seen a change of fortune after a difficult 2020. The S & P / LSTA leveraged loan index rose 1.8% for the quarter, with investors eyeing the industry’s floating rate coupons, which rise as interest rates rise. As with businesses, lower-rated loans outperformed. Thanks in part to its overweighting of loans rated below B, Credit Suisse Floating Rate High Income (CSHIX) gained 2.2% in the first quarter and beat nearly 90% of its bank lending counterparts.
A global ripple effect
The rate hike spread across the globe as sovereign bond yields soared in the first quarter. Amid fears that rising yields could derail the recovery in the eurozone, where vaccine deployment has yet to accelerate significantly, the European Central Bank signaled in March that it would pick up speed. of its asset purchases in the second quarter. In contrast, the Bank of England took a stance closer to that of the United States, leaving monetary policy unchanged in March, viewing the rate hike as a sign of economic optimism. Meanwhile, the Bank of Japan made some subtle adjustments following a three-month review of its monetary policy, but generally maintained its accommodative stance.
Given the relatively strong pace of economic recovery in the United States, the US dollar strengthened against a basket of currencies during the quarter. This partially cushioned the 2.5% drop in the US dollar hedged version of the Bloomberg Barclays Global Aggregate Index for the quarter, while the unhedged version of the index fell 4.5%. Hartford World Bond’s (HWDIX) The combination of increased exposure to the US dollar and a shorter duration positioning allowed it to post a stable return for the quarter, which outperformed nearly all peers in the global bond category, which are either not hedged, or tactically manage exposure to non-US currencies.
Emerging market debt had started to look attractive to investors in the second half of 2020, but rising US yields brought it to a halt in the first quarter of 2021, reducing the relative attractiveness of sovereign debt markets. emerging riskier. In March, Brazil’s central bank raised interest rates by 75 basis points as it sought to tackle a recent spike in inflation. Turkey also raised its policy rate in March amid rising inflation, although its central bank chief was sacked shortly after the rate hike in a dispute over the decision. Overall, emerging market debt denominated in local currency has lagged against hard currencies; the JP Morgan index for the former fell 6.7%, while the latter fell 4.5% for the quarter. The lightness of the rates in local currency made it possible to maintain the obligation of Pimco Emerging Markets Bond (PEBIX) 4.8%close to that of its typical counterpart in the emerging market bond category.
Munis helped by Stimulus
Despite the jump in rates, US municipal bonds held up relatively well in the first quarter, supported by strong investor demand. The credit outlook for the munis was boosted by the US $ 1.9 trillion fiscal stimulus package, which allocated $ 350 billion in federal aid to state and local governments. Muni investors also digested the Biden administration’s plans to introduce tax reform and come up with an infrastructure spending program. Credit fundamentals of armed issuers showed signs of improvement during the quarter. The State of Illinois was one of these transmitters; S&P raised its outlook from negative to stable in March.
In this context, the theme of substandard tariffs outperforming in the quarter also extended to the municipal market. The Bloomberg Barclays Municipal Bond Index posted a modest loss of 0.4%, while the Bloomberg Barclays High Yield Municipal Bond Index rose 2.1% over the period. BlackRock High Yield Municipal (MAYHX) was one of the top performers during the quarter in the high yield munitions category, up 2.5% due in part to its overweighting of lower rated fares.