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With a sustained rise in interest rates in the coming months a distinct possibility as of this writing, we thought now would be an opportune time to take a close look at some potential impacts of higher rates on clients’ fixed income portfolios. To do so, we compared the hypothetical five-year performance of the Bloomberg US Aggregate Bond Index under three different illustrative scenarios that could play out going forward: 1) rates remain unchanged; 2) rates rise abruptly; and 3) rates rise gradually (i.e., over three years).

Key takeaways for fixed income investors

A few of our main takeaways from this analysis were as follows:

  • While abrupt rises in rates might lead to short-term drawdowns in fixed income portfolios, they can at times be desirable for longer-term investors, given opportunities to…

Congress has effectively “kicked the can down the road” by raising the statutory debt limit sufficiently to meet Treasury obligations until December 3. This is by no means a solution to the problem, but rather just delays the inevitable uncertainty related to the debt “ceiling” drama that is likely to build as December approaches.

US Treasury bills (T-bills) are continuing to react to the ongoing uncertainty. Notably, we have observed a noticeable “cheapening” of T-bills scheduled to mature in December, creating a “hump” in the T-bill yield curve that moderates in late December and into January (Figure 1). In our view, this turn of events does not present an opportunity for bond investors to reach for incremental yield, as we believe they should instead be focused on preserving liquidity through their T-bill allocation.

Treasury market jitters

In anticipation of the possibility of a technical debt default by the US government, T-bills with maturities falling shortly after the new December 3 deadline to raise the debt limit are commanding a…

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Balaji Venkataraman
Balaji Venkataraman
Investment Specialist
Timothy Smith
Tim Smith
Fixed Income Portfolio Manager

The challenges of the past 18 months or so have highlighted the potential for environmental, social, and governance (ESG) factors to become even more relevant to asset management and have underscored the ever-increasing importance of stewardship by fiduciaries and active investors alike. ESG has quickly become one of the defining investment criteria of this decade — a trend we have little doubt will endure in 2022 and beyond.

We have long believed that mounting sovereign debt burdens pose a risk to investors, even in developed markets. At the very least, investors are not being adequately compensated for investing in the most heavily indebted countries. Given the sharp rise in government debt levels in response to the global COVID-19 crisis, it’s an opportune time for sovereign bond investors to refresh their investment frameworks, the particular metrics to be applied, and their country selection methodologies, including the ESG factors underlying investment…

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SUSTAINABILITY
Marion Pelata
Marion Pelata
Fixed Income Portfolio Manager
London
Martin Harvey
CFA, CFTC
Fixed Income Portfolio Manager
London
Jitu Naidu
Investment Communications Manager
Boston

Last week, a blog post titled Fixed income investors warily eye Congress and the Fed discussed three likely government policy drivers of fixed income markets in the period ahead — US monetary policy, US fiscal policy, and the US debt ceiling. Here, we’ll take the next step of briefly highlighting some fixed income market sectors where investors might turn for attractive total return opportunities in today’s challenging environment. Indeed, it’s perhaps the most pressing question many fixed income clients have been asking lately.

A supportive US policy backdrop

The prevailing US monetary and fiscal policy backdrop continues to be broadly supportive of credit fundamentals, but many credit sectors are not currently…

MARKETS
Brij Khurana
Brij Khurana
Fixed Income Portfolio Manager
Boston
Amar Reganti
Amar Reganti
Investment Director
Boston

From rising inflation to the COVID Delta variant and more, there is no shortage of risks and challenges facing investors in today’s global market landscape. But from our perspective, many fixed income market participants have been more or less “looking past” such macro concerns in favor of a more upbeat narrative around continued economic recovery and growth. This narrative has gained ample support from the global trend of ongoing monetary and fiscal policy stimulus, particularly in the US, since the onset of COVID. What happens in Washington doesn’t stay in Washington.

With that in mind, let’s examine the key US government policy catalysts that have been moving fixed income markets in recent months and may continue to do so in the…

MACRO
Amar Reganti
Amar Reganti
Investment Director
Boston
Jitu Naidu
Investment Communications Manager
Boston

Sustainable investing is no longer the exclusive domain of equity investors. Indeed, there is a growing consensus that sustainability can be just as critical to investment outcomes in fixed income markets. Although environmental, social, and governance (ESG) integration and adoption have historically been slower in fixed income as compared to equities, investor demand for “green bonds” and other sustainable fixed income solutions has risen rapidly in recent years, particularly since the onset of COVID-19. Accordingly, the pace of new product innovation and proliferation has picked up as well.

Case in point: The booming global market for green/sustainability bonds has now expanded to convertibles — hybrid bonds that can be converted from debt into equity. While European debt issuers have thus far comprised most of the volume in these green, sustainability-linked, and/or social bonds, US and Asian issuers have become increasingly active in the space. The recent uptick of issuers selling green/sustainability convertible bonds includes companies focused on…

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SUSTAINABILITY
Raina Dunkelberger
Raina Dunkelberger
CFA
Investment Specialist
Boston
Michael Barry
Michael Barry
Fixed Income Credit Analyst
Boston

As credit spreads have compressed to post-global financial crisis tights, and with bond yields hovering near all-time lows, I believe the total and excess return prospects for investment-grade fixed income look rather grim. Tight valuations, coupled with some looming risks on the horizon (the COVID Delta variant, inflationary pressures, fading fiscal stimulus, and China’s slowdown), may present an opportunity to “take some chips off the table,” so to speak. I recommend reducing both credit and interest-rate risk in many investor portfolios.

The technical backdrop remains strong

Investment-grade credit has been well-supported by strong demand from non-US investors and the domestic pension community. For overseas investors, US credit is still their best option on the yield “menu” (made even more attractive on a currency-hedged basis), given lower prevailing yields across most other developed markets. Many defined benefit pension plans have been…

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MARKETS
Connor Fitzgerald
Connor Fitzgerald
Fixed Income Portfolio Manager
Boston

Figure 1 highlights the six-month trailing correlation between the S&P 500 Index and the 10-year US Treasury bond as of 20 July 2021. This stock-bond correlation has shot up over the past six months or so from near all-time lows to its highest levels since before the 2008 global financial crisis. What does it mean?

Figure 1

Six-month stock-bond correlation

First, one caveat: The equity-bond correlation can be volatile, particularly amid fears of monetary policy tightening — for instance, a sharp spike around the…

MACRO
MARKETS
Nick Petrucelli
Nick Petrucelli
CFA
Portfolio Manager
Boston
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It’s been a volatile ride for the US fixed income market through the first half of 2021. After interest rates seemed to be more or less “renormalizing” in their climb back to pre-pandemic levels, the US Treasury market rallied: In the span of three months, the yield on the 10-year note dropped from 1.74% on March 31 to 1.45% on June 30.

To many market participants, this downward move may seem counterintuitive. US economic activity has continued to pick up with the widespread, successful rollouts of the COVID-19 vaccinations. Accommodative monetary policy along with generous fiscal policy should be a strong tailwind to economic growth into the second half of 2021 and beyond. And inflationary pressures have clearly increased over the past few months.

In theory, all of this should translate into higher interest rates, but that hasn’t…

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Amar Reganti
Amar Reganti
Investment Director
Boston

In our last blog post in March, we recommended a slightly defensive risk posture for high-yield investors, with a focus on individual security selection. In our view, today’s high-yield bond market requires a carefully balanced approach. We remain selective with a modestly defensive risk tilt given rich valuations, while recognizing that low spreads may last longer thanks to ongoing monetary and fiscal support. We will watch for signs of central banks tightening or deteriorating liquidity before turning more defensive.

Macro environment: Positive

  • At the time of writing, short-term economic data and corporate earnings are as good as it gets, thanks to the stimulus. We expect a modest slowdown into the second half of 2021.
  • Inflationary pressures are building across both emerging markets (EM) and developed markets (DM), with price rises potentially spilling over from goods into services. Policymakers view these pressures as a transitory phenomenon, but we will monitor to determine whether they prove more enduring.
  • We are concerned about these dynamics and…
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Christopher Jones
CFA
Fixed Income Portfolio Manager
Boston
Michael Hong headshot
Michael Hong
CFA
Fixed Income Portfolio Manager
Boston
Konstantin Leidman headshot
Konstantin Leidman
CFA
Fixed Income Portfolio Manager
London

For fixed income investors, varying the amount of credit risk in your portfolio can exert a major influence on the portfolio’s realized alpha. Indeed, historical data shows that this single factor can have a larger impact than decisions around what bond sectors or individual issuers to invest in. Accordingly, it’s worth spending some time thinking about precisely how much credit risk to take and when. My latest research in this area focuses on the role that valuation can play in adjusting credit risk over an economic cycle.

Methodology at a glance

I looked at the strategic timing of buying and selling credit exposure (in the form of corporate bonds, using cash or US Treasuries as a funding source) with low turnover, and using market valuation as the sole buy/sell signal. There are, of course, other predictive drivers of credit returns, such as…

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Robert Burn
Rob Burn
CFA
Fixed Income Portfolio Manager
Boston

The US Federal Reserve’s (Fed’s) message on inflation is clear: Higher domestic inflation is likely in the period ahead, but it should be “temporary” in nature. This begs several questions, among them: What exactly does “temporary” mean? Which price increases, if any, could be longer lasting? And if higher inflation proves to be “stickier” than anticipated, how should investors position their portfolios?

The Fed’s latest forecast is for the Consumer Price Index (CPI) to rise to 2.6% this year (which it already hit in March), before settling back down to just over 2% in 2022 and 2023. Likewise, market expectations (as observed in recent “breakeven” inflation rates) are for US inflation to pick up in the near term and then come down longer term. Yet I am hearing from some of my analyst colleagues that many areas of the economy are facing stubborn supply shortages and upward price pressures, including freight, semiconductors, housing, raw materials, and labor.

Thus, in my view, the risk is that higher inflation may have a longer-than-expected “tail” before…

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THEMES

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Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston

With front-end US interest rates flirting with the zero mark recently, the question of how to manage cash investments in a world of ultralow or even negative yields has been top of mind these days. So I’d like to share my latest thoughts, from an investment treasurer’s standpoint, on how investors with cash positions might navigate this challenging landscape.

Nothing special about ultralow or negative rates

The decline in yields over the past year or so has had a meaningful impact on the search for incremental alpha, particularly in the cash and short-duration space. Many institutional clients need or want to put languishing cash balances to work in an effort to…

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Jeff Saul
Jeff Saul
Manager, Investment Treasury & Investment Implementation, EMEA
London

Since January 2021, many investors have come around to the view that the US appears poised for a strong rebound in economic growth, driven by fiscal stimulus, vaccine administration, and economic reopenings. Meanwhile, bottlenecks in global supply chains have made it more challenging to meet increased demand for goods and services, causing input costs to rise across a number of industries.

Taken together, these developments have led to mounting inflation expectations and upward movements in interest rates. Year to date through 12 April 2021, the 10-year US Treasury yield has risen 75 basis points (bps) to 1.67%. The spread between the fed funds rate and the US 10-year Treasury note, a general proxy for yield-curve steepness, is also up meaningfully.

I believe the risk of further rises in inflation expectations and interest rates is not yet fully priced into markets. There are steps fixed income investors can take now to manage this growing risk to their portfolios. One way to do so may be via allocations to higher-income, shorter-duration assets such as floating-rate loans (FRLs).

The “duration rotation” is underway

In today’s low-yield world, a steepening yield curve can have a material negative impact on…

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Dave Marshak headshot
David Marshak
Fixed Income Portfolio Manager
Boston

In recent years, nearly every asset owner I have spoken with has had questions about their fixed income allocations: With yields as low as they are, can a traditional fixed income allocation still serve as an “all-in-one” diversifier? Should I be worried about risks in the credit market? What role should alternatives play in filling gaps in my portfolio?

The pandemic only added to the questions. It created an unusual level of disruption in capital markets, leaving diversification, the bedrock of strategic asset allocation, in short supply. At the same time, asset owners have had to contend with unprecedented market narrowness and structure issues, and the risks of monetary and fiscal policy experiments. And the likelihood of continued low yields (despite the recent uptick) suggests that traditional fixed income will struggle to produce the total return that many have come to expect and may offer less protection from volatility. While I still see a role for government bonds as ballast, I think complementary allocations need to be considered.

An alternative path to diversification

For many asset owners, the first option that comes to mind is private credit. But while private credit may well support return-seeking objectives, I don’t think it does much to…

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Cara Lafond
Cara Lafond
CFA
Multi-Asset Strategist
Boston

In our last blog post, we described the secular forces that we believe are driving the transition to a new fixed income reality characterized by more frequent market dislocations. Here, we lay out four steps investors can take to build a new fixed income allocation that is equal to today’s challenges and opportunities.

1. Rethink how to construct a fixed income allocation.

It’s best to start with what we know has changed. We know that inflation may be poised to rise in many countries, which could have important implications for global currencies and interest rates. We know also that the fixed income markets have evolved to become increasingly…

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Emily Bannister
Emily Bannister
CFA
Investment Director
Boston
Richard Gilmartin
Rich Gilmartin
Investment Director
Boston

Most of the past decade-plus has been characterized by declining interest rates and tightening credit spreads. Against this backdrop, many traditional fixed income benchmarks have performed well, particularly those with longer durations and meaningful credit components.

However, we believe 2021 could mark a transition to a new fixed income reality wrought by ongoing structural changes, potentially leading to more frequent dislocations across market sectors. Here we describe the secular forces that we believe are driving these changes, to be followed by a proposed solution for fixed income investors in our next blog post.

Structural shifts in consumer behavior

The COVID-19 crisis has driven increased adoption of technology and structural shifts in consumer behavior, some of which are…

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Emily Bannister
Emily Bannister
CFA
Investment Director
Boston
Richard Gilmartin
Rich Gilmartin
Investment Director
Boston

When Janet Yellen was confirmed as US Treasury Secretary in January 2021, questions inevitably resurfaced as to whether the Treasury should begin issuing a 50-year or even a 100-year ultralong note.

Just a few years ago, the Treasury’s debt managers, in consultation with the Treasury Borrowing Advisory Committee (TBAC), reviewed the potential issuance and concluded that it would not meet the Office of Debt Management (ODM)’s mandate of financing the government at the lowest possible cost of debt. Moreover, an ultralong note would present a challenge to the Treasury’s goal of “regular and predictable” issuance.

My purpose here is not to advocate for or against ultralong issuance, but rather to…

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Amar Reganti
Amar Reganti
Investment Director
Boston
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