Head - Fixed Income Strategy
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After the unprecedented monetary policy response to the pandemic, US rates have also decided to take a long holiday. We set out our favored fixed income positioning for this environment.
The “staycation” has become somewhat familiar to many of us. Whether personal or based on travel limitations, vacations at home have become quite common. Following the fastest market correction in history, and the extraordinary policy response that quickly followed, US rates have also decided to take a long holiday. Indeed, yields on 10-year US Treasuries (UST) have traded sideways since April, averaging 0.65%. The steepening of the yield curve has also stalled, with the yield difference between 3-month T-Bills and 10-year UST flat-lined at 50bp. Though the UST market has gained a healthy 9.5% in 2020 (thru July 28), only 90bp of return has come over the last four months.
Looking ahead, US rates are likely to face several obstacles. The path of COVID-19 will continue to weigh on investors’ minds, with the acceleration of infections slowing reopening’s and suppressing consumer demand in the effected cities. Additional fiscal stimulus faces uncertainties over timing and size, contributing to investor restraint. The US Presidential election may require markets to discount issues like higher corporate taxes or infrastructure spending. Of course, let’s not forget Fed policy. Zero policy rates and purchases of Treasury and mortgage bonds have pushed real yields down sharply and has suppressed rate volatility.
We continue to favor portfolio positioning down in quality. We believe it’s where the value lies. This holds true whether its US municipals, high yield bonds or in structured credit. However, there is a big difference between moving down in quality and over-reaching for yield. We express caution on the latter. We advise being selective and utilizing an active approach. Our strongest convictions are in “Fallen Angels”, non-agency residential mortgage bonds and lower-rated investment-grade. Preferred stock and parts of the emerging markets also offer good value.Read Bond Market Monthly