1Q 2019— Taxable Fixed Income

Jamie Mullen
Senior Portfolio Manager
Eric Kazatsky
Portfolio Manager

Fixed income returns were robust during the quarter based on the Fed’s change in messaging to a dovish stance. The 10-year Treasury bond mostly traded in a range in January and February of a 2.60 to 2.80 yield. March 1st saw an aggressive rally from 2.755% to a close the month at 2.406% according to Bloomberg data.

By the end of the quarter, it was reported that $10.6 trillion of global debt was trading at negative yields. The combination of negative yields, a dovish tone from the Fed, a global economic slowdown, and just plain old positive yields in the U.S.A. really lit the fire for a bond grab-fest.

Returns were pervasive and, in no particular order, were driven by:

  • Oversold fixed income markets in the fourth quarter of 2018
  • U.S. Treasury rally
  • Flattening yield curve
  • A barbell strategy that improved returns in the longer end of our duration buckets
  • Spread compression in investment grade and high yield bonds

As you can see, the market has responded to a complete change of stance by the Fed, but that is in the rearview mirror now, and we need to look at the road straight ahead through the windshield.

The end of the Mueller investigation and possible trade agreement with China have reduced volatility for equity markets. A rising equity market should keep high yield spreads contained as yield starved investors will continue to add money to the asset class. A dovish tone from the Fed should keep investment grade corporate spreads range bound. The combination of these events and an upcoming election in 2020 will possibly mean the talk of an infrastructure bill supported by both parties. This supports the growth of the low employment story for the economy and signals tailwinds for equities.

An alarming part of the December sell-off was that it did not appear that the bond and the stock market can withstand a 3% 2-year Treasury interest rate without selling off. At 3%, state tax-free U.S. Treasuries appear to be a real competitor for capital especially after a 10-year bull market in equities.

The negative feedback loop is: Fed tries to tighten, stocks sell off, Fed needs to abruptly reverse course, etc… The forward asking question then becomes: are “lower for longer” interest rates back? With that question a looming possibility, we have been proponents of a barbell strategy and will continue on that path for now.

Source: Bloomberg, Ned Davis Research

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