The Long and the Short of It
As Q1 draws to a close, investors are benefitting from the safe haven of longer maturity bond markets.
By Steve Van Order, Fixed Income Strategist
Would you have believed a prediction that bonds would rally in a quarter when the Fed shifted to a more hawkish stance on policy? That's the way Q1 is shaking out. You know those intermediate and long maturity bonds that had been abandoned by many investors? Well, the ten-year T-note yield has fallen 30 basis points (bps) and the 30-year bond yield is down 40 bps as we near quarter end. In contrast, two- and three-year T-note yields are up about plus-or-minus 8 bps. The gap narrowed between the yields on short-term bonds and long-term bonds in other bond market sectors as well. This is not the first time the bond gods have humbled the denizens of Bondland, nor will it be the last.
So, in a quarter when the consensus expected stocks to outperform bonds, why did bonds as an overall market do so well? The reasons were varied. Bond returns underperformed stocks by a record 30 points in 2013.1Â Bonds simply became too cheap versus stocks. Geopolitical troubles, foremost in the Ukraine, boosted demand for liquid government bonds. Concern about China's economic growth and financial system fed into broader worries about global growth, and so emerging markets suffered outflows that favored safe haven bond markets. Moreover, the trend in positive U.S. economic surprises finally rolled over, and fell deeply into negative surprise territory.2 While the weather was certainly a culprit, it is not yet clear if it was all weather-related. And finally, bond technicals were very firm, with the return of fund inflows. Income from bond coupon payments in 2014 is expected to be greater than the net new supply of U.S. fixed income.3
A tasty way to describe why long bonds outperformed in Q1 is that two weeks ago the Fed served up a big "yield curve pancake" to the market. Increased belief that the Fed will hike earlier than thought pressured shorter maturity yields upward in Q1 (while dropping prices). In contrast, the longer 30-year bond benefited from the Fed decision, as the curve was deemed too steep for the modified Fed outlook. Big momentum trades in Treasuries pancaked the yield curve and also helped pull lower the long maturities in municipal and corporate credit markets. The 30-year yield fell (and prices rose), as opposed to simply rising less than the three-year. That's why being long in maturity was far from wrong in Q1.
1. We compared the calendar-year percentage changes for the Bank of America Merrill Lynch investment-grade corporate bond index and the S&P 500 index.
2. The surprise index appears to have bottomed and a spring pickup seems likely.
3. Per J.P. Morgan.
This commentary represents the opinions of the author as of March 31, 2014 and may change based on market and other conditions. These opinions are not intended to forecast future events, guarantee future results, or serve as investment advice. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither Calvert Investment Management, Inc. nor its information providers are responsible for any damages or losses arising from any use of this information. Calvert may have acted upon this research prior to or immediately following publication. In addition, accounts managed by Calvert Investment Management, Inc. may or may not invest in, and Calvert is not recommending any action on, any companies listed.