2Q 2020 SMA Fixed Income Commentary — “Whatever It Takes” Squared

Jamie Mullen
Senior Portfolio Manager

On July 26th 2012, Mario Draghi issued his famous “whatever it takes” speech that became a defining moment in turning around the Euro Crisis enveloping the old world. On April 9th 2020, the Fed announced unprecedented steps to keep credit flowing. The Fed unveiled programs to provide an additional $2 trillion in loans to companies and to help cash-strapped municipalities and states.

One of the highlights of the Fed’s April 9th announcement was an expansion in the Fed’s $500 billion Municipal Lending Facility (MFL) providing a backstop to the municipal bond market. To buoy the taxable markets, the Fed expanded the size and scope of the Primary Market Corporate Credit Facilities (PMCCF) and the Secondary Market Corporate Credit Facilities (SMCCF). The result of the Fed’s announcement produced the best quarter in equities since 1998 and dragged bonds along with it for the reflation ride.

Fixed Income markets responded sharply and ended higher for the quarter. Using the Bloomberg Barclays Municipal Bond Total Return Index as a reference, the muni market gained 2.72% on a total return basis during the second quarter. The Bloomberg Intermediate Corporate Bond Index gained 7.63% for the quarter. This moved both fixed income classes back to positive territory for 2020. Other key drivers contributing to the positive returns for the quarter included an accommodative Fed leading to a lower rate backdrop, positive fund flows for the quarter, and optimistic investor sentiment surrounding the potential economic reopening.

Here is how the quarter unfolded:

Municipal Fixed Income Strategy Overview

Municipal bonds finished sharply higher in the second quarter. Using the Bloomberg Barclays Municipal Bond Total Return Index as a reference, the muni market gained an impressive 4.72% on a total return basis during the second quarter. According to the Investment Company Institute (ICI), the municipal bond asset class experienced positive fund flows totaling over $12.7 billion during the second quarter (as of 06/24/2020), reversing record outflows for the muni asset class in March. Some of the key drivers contributing to the positive return for the quarter included an accommodative Fed leading to a lower rate backdrop, an expansion in the Fed’s $500 billion Municipal Lending Facility (MFL), positive fund flows for the quarter, and optimistic investor sentiment surrounding the potential economic reopening. At the beginning of the quarter, the 5-year Municipal Market Data (MMD scale) scale read 1.19% on April 1st and finished the quarter on June 30th reading 0.41%, representing a 78-basis point drop during the quarter.

April

In April, improving coronavirus trends, optimism surrounding a potential economic reopening, and aggressive monetary and fiscal policy measures improved investor sentiment as we saw positive fund flows return to the municipal market. A positive technical backdrop combined with renewed optimistic investor sentiment helped push muni yields lower by 10 bps, finishing the month with a 1.09% yield on April 29th, using the 5-year MMD scale. The muni market finished April with a 0.63% positive performance as referenced by the Bloomberg Barclays 5-year Muni index. At the end of April, Senator Mitch McConnell (R-KY) said he would be in favor of allowing struggling states with high public pension burdens to declare bankruptcy rather than offer them a federal bailout. McConnell’s comments proved to be one of the more noteworthy headlines during the quarter as muni markets responded negatively to the remarks, causing prices to fall and yields to rise as we exited April and started May. The muni volatility was short-lived as many politicians publicly questioned the constitutionality of state bankruptcies. Investor confidence returned to the muni market when the Fed announced an expansion to the MLF, lowering the entity population threshold level from 500,000 to 250,000 and increasing the maturity tenure of eligible issues from 24 months to 36 months, allowing more entities to participate in the borrowing facility.

May

Municipal bonds continued to rally in May amid this positive news from the FED, the slowing growth in reported coronavirus infections, and increased optimism over a potential economic reopening. The 5-year MMD scale finished May with a yield of 0.38% and the Bloomberg Barclays 5-year Muni index improved by 2.65% during the month. Municipal bond mutual fund flows were positive in May as investors added over $5.1 billion into the asset class during the month according to ICI.

June

The municipal bond market logged a modest rise in June as the Bloomberg Barclays 5-year Muni index improved slightly by 0.53%. Strong performance at the beginning of the month was abated by renewed coronavirus fears as new hotspots, particularly in the southern and western states, started to emerge during the second half of the month. The Fed issued forward guidance after its June 10th meeting, indicating it planned to hold the Fed Funds rates inside the 0.00%-0.25% range through year-end 2022. The municipal market interpreted the Fed’s dovish decision as favorable. Positive fund flows continued in June as investors added over $10.8 billion (as of 06/24/2020) according ICI to municipal bond mutual funds during the month. The 5-year MMD scale finished June up three bps yielding 0.41% on June 30th. The .41% represented a 78 basis point drop in yields after beginning the quarter at 1.19%.

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The S&P 500 measures the performance of the 500 leading companies in leading industries of the U.S. economy, capturing 75% of U.S. equities.

Bloomberg Barclays U.S. Aggregate Bond Index: The index is unmanaged and measures the performance of the investment grade, U.S. dollar denominated, fixed-rate taxable bond market, including Treasuries and government-related and corporate securities that have a remaining maturity of at least one year.

The Bloomberg Barclays 5 Year Municipal Bond Index is a capitalization weighted bond index created by Bloomberg Barclays intended to be representative of major municipal bonds of all quality ratings with an average maturity of approximately five years.

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