First Quarter High(Low)lights
- During the quarter, the emergence of COVID-19 in the US sparked record-setting market volatility across asset classes, prompting unprecedented fiscal and monetary policy responses intended to combat the emerging economic and financial fallout from the pandemic.
- Credit markets deteriorated significantly, with spreads widening to levels last seen during the financial crisis. Likewise, the US Treasury yield curve fell dramatically during the first quarter, as global investors sought liquid, high-quality assets.
- Economic data weakened precipitously in the final days of the quarter, as the impact of various global lockdowns and changing consumer behaviors began to emerge in reported statistics.
- The Federal Reserve (Fed) responded with a battery of measures intended to ease financial conditions and improve market liquidity and overall functioning.
- Following the Fed’s intervention, as well as unprecedented fiscal support from Congress, fixed income market conditions improved towards the end of the quarter.
- We expect continued volatility in the foreseeable future, as developments related to COVID-19 continue to unfold.
Maintaining a benchmark-like duration stance across strategies, with a modest underweight to the front end of the curve.
Modestly Overweight: Adding to higher- quality issues in longer-maturity strategies
Overweight Financials and select BBB Industrials; focused in maturities less than 5 years. Increased allocations in high-quality, defensive sectors given dramatically improved valuations.
Maintained overweights in Asset-Backed and Agency Mortgage-Backed Security allocations.
First Quarter Sector Review
The healthy backdrop for financial markets at the start of the year deteriorated rapidly in March, as global cases of the novel coronavirus (COVID-19) surged, quashing any optimism surrounding the effective containment of the spread. Volatility surged, as many segments of the fixed income market suddenly failed to function properly due to an abrupt decline in liquidity. Recognizing the immediate threats this posed to the financial system, the Fed moved decisively to enact bold policy decisions to facilitate market liquidity, attempting to ensure markets could function properly during this time of rapid re-pricing.
As the pandemic sparked a sudden, global flight to quality across financial markets, investors sought refuge in the US dollar and US Treasuries. Treasury yields collapsed,
Bloomberg Barclays Aggregate Bond Index
Duration (Mod. Adjusted)
Option-Adjusted Spread (OAS) (bps)
OAS Change Quarter-over-Quarter
Excess Returns: 3 Months
Non-Corporate Investment Grade
U.S. Mortgage Backed Securities
CMBS: Erisa Eligible
U.S. Corporate High Yield
Source: Bloomberg Barclays
See Important Disclosures at the end of this document for additional information.
Monetary Policy: Keep On Using Me…’Til You Use Me Up
- Extending swap lines to global central banks to ease funding stress for US dollars.
- Lowering the discount window rate to 25 bps and encouraging banks to utilize borrowing capacity to extend credit.
- Expanding repo facilities from last fall to improve liquidity in the US Treasury market.
- Restarting quantitative easing, with expanded purchases of US Treasury and Agency MBS securities at “the amounts needed to support the smooth market functioning”.
- PDCF (Primary Dealer Credit Facility): Mechanism to support funding securities inventories on broker/dealer balance sheets.
- CPFF (Commercial Paper Funding Facility): Supports the short-term borrowing needs of top-tier (A-1/P-1) commercial paper issuers.
- MMLF (Money Market Liquidity Facility): Provides liquidity to prime money market funds experiencing significant outflow.
- TALF (Term Asset Liquidity Facility): Mechanism to fund purchases of high-quality, new issue asset-backed securities.
Federal Reserve Total Assets ($ in trillions)
By the end of the quarter, an improved tone was evident across the corporate new issue market, where supply has surged and investor demand has returned. New issue markets provided price transparency for investors challenged by the dislocations in the secondary market. Swelling issuance in the second half of March produced record monthly and quarterly supply, the latter approaching almost $500 billion. The calendar was dominated by domestic, non-financial companies and skewed towards higher-quality issuers, with approximately two-thirds rated single A or higher, which likely reflected issuers that were accustomed to accessing commercial paper markets for ongoing funding. Pricing on these deals came at very attractive levels, consistent with where BB-rated high-yield debt had been valued just months earlier! The breadth of issuers expanded recently to include both lower-quality BBB and selective cases of high yield. Credit markets are slowly beginning to function more normally, aided by improved risk appetites and early signs of potential success in “flattening the curve” of new COVID-19 cases.
ICI Total Bond Estimated Weekly Net New Cash Flow ($ in billions)
Outlook: Economic Data is U-G-L-Y, but It’s Got an Alibi
Despite the high level of uncertainty about how future developments will impact markets, we have identified many attractive investment opportunities over the last month. We believe it’s important to emphasize that many of these opportunities exist due to the defensive moves we made in client portfolios over the preceding months. As discussed in recent quarterly commentaries, valuations in credit had become increasingly unattractive towards the end of 2019. We reduced allocations in corporate credit across strategies, favoring AAA-rated structured securities or increased Treasury weightings instead. While the fundamental backdrop (at the time) was still very healthy, the compensation to take risk was insufficient for doing so. As corporate credit spreads repriced dramatically wider during March, we capitalized by taking advantage of the dislocations in short-dated markets by purchasing high-quality bonds that were being indiscriminately sold by asset managers scrambling to meet client outflows. These massive outflows, coupled with a lack of liquidity in markets, led to instances of high-quality debt trading at deeply distressed levels. In longer-dated strategies, the new-issue market provided excellent opportunities to selectively add exposure to highly rated companies in defensive industries, with ample balance sheet flexibility, and at attractive spreads.
The Bloomberg Barclays U.S. Aggregate Corporate Index represents the total return measure of the corporates portion of the Barclays U.S. Aggregate Index.
The Bloomberg Barclays U.S. High Yield Index covers the universe of fixed rate, non-investment grade debt. Canadian and SEC-registered global bonds of issuers in non-emerging countries are included. The index includes both corporate and non-corporate sectors.
This publication is for informational purposes only. Information contained herein is believed to be accurate, but has not been verified and cannot be guaranteed. Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security and are subject to change without notice. Statements in this material should not be considered investment advice or a forecast or guarantee of future results. To the extent specific securities are referenced herein, they have been selected by the author on an objective basis to illustrate the views expressed in the commentary. Such references do not include all material information about such securities, including risks, and are not intended to be recommendations to take any action with respect to such securities. The securities identified do not represent all of the securities purchased, sold or recommended and it should not be assumed that any listed securities were or will prove to be profitable. Past performance is no guarantee of future results.
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