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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…
MARKETS
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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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…

MARKETS
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…

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…

MARKETS
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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The transition to the “sunsetting” of long-standing LIBOR benchmarks — initially slated for 31 December 2021 — has been fraught with delays and uncertainty, thanks in no small part to the ongoing COVID-19 crisis. There has been progress, however. A number of recent developments reinforce the commitment by regulators and central banks to wean market participants off their reliance on IBORs (interbank offered rates) and to embrace alternative reference rates.

The UK FCA announcement

  • On March 5, the UK’s Financial Conduct Authority (FCA) officially announced the eagerly anticipated cessation and non-representation dates on 35 LIBOR benchmarks across various tenors and…
MACRO

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Matthew House
Matthew House
Fixed Income Portfolio Analyst
Boston

Interest rates have been rising since August 2020, with the yield on the 10-year US Treasury bond having drifted 100 basis points (bps) higher over the past six months or so. But recent rate action has really caught the market’s attention, particularly the 10-year yield’s swift 30 bps increase and the spillover into global equity markets.

Is the latest bout of “rate repricing” due to higher inflation expectations? Stronger economic growth? Treasury supply issues? “Fed fighting”? Let’s try to make sense of it all.

Yields have risen for the right reasons — Rates have been adjusting to prospects for better growth and higher inflation for months now, reflecting an improving pandemic outlook and ample policy support. Rising inflation expectations are baked into wider spreads between Treasury yields and real (inflation-adjusted) yields, using 10-year Treasury Inflation-Protected Securities (TIPs) as a proxy. Orderly rate moves have been absorbed by…

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

In my 2020 insight, “Debunking four common myths about CLOs,” I highlighted what I saw at the time as compelling value in several tranches of the collateralized loan obligation (CLO) market. Looking at recent CLO spreads and valuations, I believe that remains the case as of this writing.

CLO spreads rebounded quickly from last year’s COVID-19-induced sell-off. Despite spread tightening across the capital structure over the past year, I still find CLOs attractive versus competing asset classes, such as corporate credit (Figure 1)…

Figure 1

CLO spreads vs corporate credit spreads

…especially in light of my positive outlook for CLO fundamentals. As the market has recovered, the underlying bank loan collateral credit metrics have…

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Alyssa Irving
Alyssa Irving
Fixed Income Portfolio Manager
Boston

In my August 2020 blog post, I highlighted a potentially compelling return opportunity in the often-scorned universe of “fallen angels” — formerly investment-grade-rated corporate bonds whose ratings have been downgraded to high-yield (i.e., below-investment-grade) status by major credit rating agencies. I noted that, within two years of being thus downgraded, fallen angels as a group have handily outperformed the broader US high-yield index (and all three of its quality subgroups) over the long term.

Fast forward to early 2021: What I call the “fallen-angel effect” appears to have lost none of its luster. And notably, my latest research revealed that it’s not limited to just…

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Robert Burn
Rob Burn
CFA
Fixed Income Portfolio Manager
Boston

My team and I often say recessions wipe the slate clean and create new investment patterns that will likely be dissociated from the last cycle. If there was a dominant theme of the last cycle — from the global financial crisis (GFC) in 2008 up to the onset of COVID-19 in March 2020 — it may have been “secular stagnation,” which I define as low nominal economic growth due to shortfalls in aggregate demand. Naturally, this begs the question of whether or not secular stagnation will still have legs in the post-COVID era.

I don’t claim to have a simple “yes” or “no” answer yet, but for now would like to share my latest thinking on the topic, to be followed by deeper dives on specific aspects of it (and hopefully more definitive answers) in additional blog posts throughout 2021.

Whence secular stagnation?

By way of context, it’s helpful to consider how we got here in the first place. Economists have attributed secular stagnation to…

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Brij Khurana
Brij Khurana
Fixed Income Portfolio Manager
Boston

Near term, our view on the high-yield market remains that a neutral-to-slightly cautious risk posture, with a heavy focus on security selection, is warranted amid spiking COVID numbers, the US political transition, the waning effects of government stimulus, and credit spreads having tightened from earlier this year. Longer term, however, our outlook is more positive as we see plenty of reasons to be optimistic as we look out nine to 12 months from now.

Macro: Strong medium-to-longer term

  • We anticipate a difficult short term marked by increased credit stress over the next couple of months, along with a possible reacceleration in high-yield defaults, followed by a much more supportive medium-to-longer term.
  • We expect the global economic backdrop to rebound strongly in 2021 and into 2022, particularly as COVID vaccines become reality and if governments deliver additional stimulus.
  • European economies could begin to show improvement as early as the first quarter of 2021, while the US economy is likely to strengthen in earnest starting in the second half of the year.
  • One big question for high-yield investors right now is: Will the market engage with the near-term downside risks or look through to…
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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

Factor investing – tilting a portfolio toward securities that have certain attributes (e.g., attractive value, quality, momentum, etc.) – has become widely accepted and practiced in the world of equities. Within fixed income, it is in a more nascent stage.

However, we believe that applying a factor-based investing framework can lead to valuable insights into what is driving performance in different sectors of the bond market. Even more important, it may allow investors to better position their portfolios to take advantage of…

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Samuel Steere
CFA
Investment Director
Boston
Brendan Fludder
CFA
Research Manager
Boston

The US Federal Reserve’s (Fed’s) recent adjustments to its monetary policy framework are impactful for short-term investor returns, affirming our expectation that short-end interest rates will likely remain at or near zero for at least the foreseeable future. This brings short investors back to the dilemma many knew all too well post-2008: With most deposits and money market funds earning next to nothing in yield, how should I invest my liquid and reserve assets?

For clients’ second-tier cash bucket (reserves or excess liquidity), here are three suggestions to modestly increase income without adding significant risk.

1. Increase duration flexibility for excess reserves

Money market funds are governed by strict rules that limit the investable universe. There has also been a surge of inflows into money markets (Figure 1), further suppressing potential income from assets meeting the money market criteria. Thus, we believe expanding one’s opportunity set beyond the traditional money market rules — while still remaining on the short end — may…

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Caroline Casavant
Caroline Casavant
Investment Analyst
Boston
Andrew Bayerl
Andrew Bayerl
CFA, CAIA
Investment Director
Boston

Baseball legend Yogi Berra famously remarked that “it’s tough to make predictions, especially about the future.” Political elections are no exception, of course. But as difficult as forecasting an election can be, predicting market reactions is arguably even more challenging. That being said, with the 2020 US elections only a few weeks away, now seems an opportune time to think through the various potential outcomes and their implications for fixed income and currency markets.

While most market participants are focused on the presidential election, which party controls the Senate is of equal importance in the event of a Biden victory; it matters less under a Trump presidency given that Democrats control the House of Representatives, with little chance of a flip there. Thus, the three possible outcomes to consider are…

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Brij Khurana
Brij Khurana
Fixed Income Portfolio Manager
Boston
Joe Marvan
Joseph Marvan
Fixed Income Portfolio Manager
Boston

The US hospital sector saw a substantial direct impact from COVID-19, primarily via the sharp decline in elective medical procedures, but also received significant aid from the Coronavirus Aid, Relief, and Economic Security (CARES) Act. So what now?

Ultimately, the performance of hospitals — and the municipal bonds (munis) they issue — will depend on the severity and duration of the current health crisis. We expect diminished revenues for the remainder of 2020, although many hospitals are cutting costs and deferring capital spending to help offset this. We believe hospitals with strong balance streets and fundamentally viable operations are best positioned to weather the crisis; for weaker hospitals, ratings downgrades are likely.

The current condition of hospitals

Coming into the pandemic, financial performance across the US hospital sector was largely stable. Most health care providers were managing through various sector headwinds, thanks to…

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Jennifer Soule
Jennifer Soule
Fixed Income Credit Analyst
Boston
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