Third Quarter 2021 | Fixed Income Commentary

Published on October 25th, 2021

Third Quarter 2021 | Fixed Income Commentary

Market Overview

The Current Income Portfolio returned 0.1% gross during the third quarter, with corporate bonds gaining by 0.2% and preferred securities declining by 0.6%. Of the preferred securities, $25 par-value securities, which have both fixed, and fixed-to-floating, rate coupons, declined by 1.1%, and $1,000 par-value securities, which only have fixed-to-floating rate coupons, gained by 0.8%.

We believe the quarter’s relatively flat performance was driven by the modest increase of just two basis points in ten-year US Treasury yields, which opened the quarter at 1.47% and closed it at 1.49%. While the overall change in government yields was minimal, from quarter to quarter, interest rate movements intra-quarter were more significant.

Third Quarter 10Y US Treasury

Source: Bloomberg

At the start of the quarter, concerns over an uptick in cases of the delta variant, coupled with waning consumer confidence, supply chain disruptions that cause shortages and bottlenecks, and various other factors, effectively dampened projections for economic growth during the second half of the year. As a result, ten-year US Treasury yields, and ten-year US Real yields, which are an indication of the market’s long-term expectations for economic growth, fell by roughly 30 bps in July, while long-term economist expectations for inflation stayed roughly the same.

As the quarter progressed, pressures on government yields appeared to ease. Market expectations began to look through the temporary factors considered to be driving economic growth to decline. At the September Federal Reserve meeting, FOMC growth forecasts for U.S. GDP were revised downward to 5.9% from 7% for 2021, while forecasts for 2022 were simultaneously revised upward, from 3.3% to 3.8%. These moves in opposite directions reflect economist expectations for an even stronger economy once global supply-chain constraints, labor shortages and transportation issues subside. Moreover, projections for the personal consumption expenditure (PCE) price index, which is the Federal Reserve’s preferred method for tracking inflation, were revised upward by 0.8%, from 3.4% to 4.2%, in 2021, and by 0.1%, from 2.1% to 2.2%, in 2022, reinforcing our belief that price increases from shortages and bottlenecks are projected to be transitory.

At the September FOMC meeting, Federal Reserve officials also released expectations for monetary policy, with respect to the tapering of asset purchases as well as to “lift-off”, as depicted by the Federal Reserve’s “dot plot” for interest rate hikes. While the conditions necessary for tapering to begin have likely been met, the hurdle for raising interest rates has “all but been met” with respect to the Federal Reserve’s goal for employment. The Federal Reserve plans to keep interest rates at current levels until inflation moderately exceeds 2% for some time, on a sustainable basis, and maximum employment has been achieved. We believe this highlights the disconnect between timeline for asset purchases and the onset of raising interest rates, in that the two do not need to go together. While it is expected that the Federal Reserve could begin the tapering process as soon as November 2021, median expectations for the first interest rate hike are not until 2023.

The CIP portfolio continues to be defensively positioned with respect to both credit and interest rate risk. Credit quality across the portfolio is strong, leverage trends have been favorable and profit margins have been stable. CIP’s corporate bonds have a lower average duration than the intermediate-term corporate bond market, which reduces the portfolio’s relative sensitivity to rising interest rates. Moreover, the inclusion of fixed to floating rate coupons in CIP’s preferred securities allocation has helped to lower portfolio volatility from changes in interest rates.  The intent to enhance yield and reduce overall portfolio risk is unchanged, and the portfolio continues to be positioned to earn high current income, without extending duration or lowering our credit quality standards.

As of September 30, 2021

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