Total Return Perspectives: January 2021
Treasury yields continued to march higher in January, with the move again concentrated in longer maturities. Mortgage spreads tightened slightly, while corporate bond spreads were mostly mixed. The market remains stuck between the push/pull of the prospect for greater fiscal stimulus and ongoing vaccine rollout versus continued lockdowns and the greatest one-month mortality rate since the pandemic began nearly a year ago.
Review:
- The Bloomberg Barclays U.S. Aggregate Bond Index (BC Agg) posted a negative return in January, falling 72 basis points. The majority of this loss stemmed from the rise in longer maturity Treasury yields. The MBS index (+0.08%) outperformed Treasuries (-0.96%) and corporates (-1.28%).
- Economic data continued to reflect broad improvement in the economy. While the headline unemployment number was unchanged at 6.7%, the broader underemployment index dropped 0.3% to 11.7% and average hourly earnings rose 0.8%. CPI rose 0.4% in the prior month, pushing the year-over-year number slightly higher to 1.4%. Housing starts and home sales accelerated, benefiting from low mortgage rates – both are at levels not seen since 2006.
- The Treasury curve resumed its bear steepening pattern, now seen in 5 of the last 6 months. While 2-year yields were little changed, the 5-year yield rose 8 basis points to 0.44%, the 10-year yield rose 18 basis points to 1.09% and the 30-year yield rose 21 basis points to 1.86%.
- Corporate spreads were little changed in January and remain relatively tight. The option-adjusted spread of the Bloomberg Barclays U.S. Corporate Index widened 1 basis point in January, ending the month at 97 basis points. Despite this widening, the corporate sector outperformed duration-matched Treasuries by 3 basis points, presumably from carry (yield).
- The Bloomberg Barclays U.S. MBS Index outperformed duration-matched Treasuries by 24 basis points. Despite the rise in Treasury yields, mortgage durations remained extremely low, owing to the moneyness of most of the index given the fall in mortgage rates. Lower coupon MBS (like 30-year FNMA 2%) continued to perform well, supported by Fed purchases. Current coupon MBS spreads tightened 4 basis points to 66 basis points, approaching their tightest levels over the past 8 years.
- The fund (-0.38%) outperformed the BC Agg (-0.72%) in January. Most of this outperformance is attributable to reduced duration profile relative to the index. Our overweight to MBS versus Treasuries also contributed to this outperformance.
Standardized performance can be viewed here: Monthly and Quarter End Performance
Outlook:
- Risk assets remain priced to perfection. To sustain these levels, Fed stimulus must continue unabated and the spread of the virus needs to decelerate. Fiscal stimulus would also be a welcome tailwind. January gave us mostly positive evidence on each of these fronts.
- We continue to favor a slight overweight to corporate bonds and MBS. Near-term risks include vaccine distribution challenges, broader and more draconian lockdowns, and a wider spread of the newly discovered (and more contagious) forms of Covid-19.
- Looking past the near term, we still believe any weakness in economic data or activity that may be observed this winter will be short-lived.
Eddy Vataru
Chief Investment Officer – Total Return
John Sheehan
Vice President & Portfolio Manager
Daniel Oh
Vice President & Portfolio Manager
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The Bloomberg Barclays U.S. Aggregate Bond Index (BC Agg) is an unmanaged index which is widely regarded as the standard for measuring U.S. investment grade bond market performance. This index does not incur expenses and is not available for investment. The index includes reinvestment of dividends and/or interest income.
The Bloomberg Barclays U.S. Mortgage Backed Securities (MBS) Index tracks agency mortgage backed pass-through securities (both fixed-rate and hybrid ARM) guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon and vintage.
The Bloomberg Barclays U.S. Corporate Index includes publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and quality requirements. To qualify, bonds must be SEC-registered. The index includes exclusively corporate sectors, including Industrial, Utility, and Finance, which include both U.S. and non-U.S. corporations.
Sector returns above are those of the Bloomberg Barclays U.S. Aggregate Bond Index.
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A basis point is a unit that is equal to 1/100th of 1%.
Coupon is the interest rate stated on a bond when it’s issued. The coupon is typically paid semiannually.
Investment grade bonds are bonds with high and medium credit quality assigned by a rating agency. For Standard and Poor’s, investment grade bonds include BBB ratings or higher. For Moody’s, the cutoff is Baa.
A mortgage-backed security (MBS) is a type of asset-backed security that is secured by a mortgage or collection of mortgages.
Duration measures the sensitivity of a fixed income security’s price (or the aggregate market value of a portfolio of fixed income securities) to changes in interest rates. Fixed income securities with longer durations generally have more volatile prices than those of comparable quality with shorter durations.
Spread is the difference in yield between a risk-free asset such as a U.S. Treasury bond and another security with the same maturity but of lesser quality.
Option-Adjusted Spread is a spread calculation for securities with embedded options and takes into account that expected cash flows will fluctuate as interest rates change.
Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.
The producer price index (PPI) is a group of indices that calculates and represents the average movement in selling prices from domestic production over time.
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