October 2021
3rd Quarter 2021 Fixed Income Review
• Q3 fixed income markets experienced slightly positive performance although Treasuries and high credit quality were still negative year-to-date
• Inflation has soared this year due to disrupted supply chains and product and materials shortages since the reopening of the economy
• FOMC signals that it could start reducing, or tapering, its asset purchases as early as November
• Despite continued low yields, U.S. Treasury yields are among the highest in the developed world continuing to attract foreign buyers
Fixed income markets in general experienced slightly positive performance in the 3rd quarter of 2021 as U.S. equity markets softened amid slower global growth and higher inflation expectations. Additionally, world central banks signaled a continuation of highly accommodative monetary policies although there are hints of slowing direct purchases. However, investment grade and U.S. Treasury index returns were negative year-to-date through the end of Q3 (see graph below).
Below are 3rd quarter and year-to-date Bloomberg Barclays fixed income index returns:
The 10-year U.S. Treasury (UST) note, a closely watched indicator of rates in general in the fixed income markets, ended Q3 2021 with a yield of 1.49%, almost the same as the 1.47% yield at the end of Q2 2021. However, for much of the quarter, the 10-year yield was below 1.40% and hit a yield low for the quarter of 1.17% in August. The 2-10-year UST yield spread, an often-cited measure of the slope of the yield curve, ended Q3 2021 at 121 basis points. That same yield spread has averaged around 60 basis points for the past five years. A wider “positively sloped” yield spread, as such, is normally indicative of a market anticipating higher interest rates in the future.
The chart below shows the changes in the UST yield curve from Q3 2020 (gold line) and the end of Q3 2021 (green line). The bar graph at the bottom shows the changes in yields for select maturities.
In their most recent meeting in September, the FOMC left interest rates unchanged, but signaled that they may start reducing, or tapering, monthly emergency asset purchases as early as November, and winding-down the policy by mid-2022. As a reminder, the Fed is currently purchasing $80 billion in Treasuries and $40 billion in mortgage-backed securities monthly in the open market in an effort to keep interest rates very low.
In the Fed’s statement following the September meeting, they acknowledged that “If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted.” In updated projections, 9 of 18 Federal Reserve officials expect to lift short-term interest rates by the end of 2022, up from 7 who expected that in June.
Additionally, the FOMC updated predictions for GDP, inflation, and unemployment. Interestingly, the Fed’s median estimate for the core Personal Consumption Expenditures (PCE) Index, the central bank’s preferred measure of inflation, is expected to be 3.7% for 2021, a marked increase from their stated target around 2%. At present, Fed officials see inflation slowing to 2.3% in 2022, and to 2.2% in 2023. Officials see GDP rising 5.9% this year and the unemployment rate is expected to be 4.8% at the end of 2021. Inflation has soared this year with the Fed’s preferred core inflation gauge, excluding food and energy, rising to 3.6% on an annualized basis in August.
Foreign sovereign bond yields generally increased during Q3 2021. Globally, negative yielding debt outstanding continued to dissipate from over $18 trillion in December 2020 to around $13 trillion at the end of the recent quarter.
Below, in blue, are 10-year bond yields from several foreign countries (sorted from low to high), as of 9/30/21. The wide disparity between the yield of the bellwether German Bund (the German ten-year note) at -0.20% compared to the U.S. ten-year note at 1.49% is indicative of two very different economic outlooks and divergent central bank monetary protocols. In following, the high relative yield of U.S. Treasuries and high-quality fixed income continues to draw support from foreign buyers.
For most fixed income accounts, save capital preservation only, we currently recommend a broad diversification of strategies, both conservative and more opportunistic, as a means of maintaining liquidity, creating cash flow, and pursuing positive risk-adjusted returns. Although positive nominal rates are still available, taking current and near-term inflationary measures into account, U.S. real rates on higher quality fixed income are generally negative. With this in mind, we currently recommend patience and higher cash balances than normal until more information is available regarding the FOMC’s plans for unwinding their ultra-accommodative monetary policies put in place following the onslaught of the pandemic
We hope you will contact your portfolio manager, or any member of our fixed income team, to discuss our thoughts on fixed income, and to learn more about opportunities we believe are both appropriate and timely.
Not Investment Advice or an Offer | This information is intended to assist investors. The information does not constitute investment advice or an offer to invest or to provide management services. It is not our intention to state, indicate, or imply in any manner that current or past results are indicative of future results or expectations. As with all investments, there are associated risks and you could lose money investing. Argent Financial Group is the parent company of Argent Trust, Heritage Trust and AmeriTrust.
For more information about the commentary found in this newsletter, please contact:
Sam Boldrick: sboldrick@argenttrust.com, Hutch Bryan: hbryan@argenttrust.com, or Oren Welborn: owelborn@argenttrust.com
