Markets had a lot to digest throughout the long month of March. The war in Ukraine and its economic impacts, oil prices, ongoing inflation, the mid-month FOMC meeting, economic data, and fiscal policy all played a role in a volatile month.
Bond market carnage continued in March, wrapping up the worst quarterly performance in fixed income in over 40 years with the Bloomberg U.S. Aggregate Index down 6% year-to-date. There were no fixed income sectors spared during March (except for the equity/bond-like preferred market). Most credit market sectors fared better than government bonds.
- Treasuries fell 3.11% while investment grade corporates fell 2.52%.
- High-yield was buoyed by a strong equity bounce and only fell 1.15%.
- EM bonds fell 2.53% percent as the volatility in Russian bonds continued to deflate the sector.
- Municipal bonds fell sharply, down 3.24%, as they could no longer hold up with taxable yields rising so swiftly.
Although equities were negative for the quarter with the S&P Index down 4.60%, luckily, for asset allocators, there was a strong rebound in March (S&P Index +3.71%). Financials were the only negative sector in March (down 0.35%) as curve flattening suggested lower net income margins for banks.
Many investors began the month with a focus on the March 16th Fed meeting, however multiple events caused market swings before then. Despite all the volatility leading up to the FOMC meeting during mid-March, the message delivered was a strong tightening tone which left investors reevaluating rates, the yield curve, and where to hide their money.
- Fed members voted 8-1 to raise short rates by 25 basis points. Only Fed governor Bullard dissented, opting for a 50 basis point increase.
- The Fed drove home the message that they would fight inflation, as their main objective. They left out specific plans for quantitative tightening of their bond holdings but suggested they would announce a plan in upcoming meetings to use the balance sheet as a tool to reach their goals.
- Projections for further rate hikes rose by the committee and the language was considered very hawkish from the street.
- Rates came under pressure and the curve flattened. Stocks rebounded as the FOMC message was apparent.
- Equity markets delivered the biggest positive return in two years the week of the announcement as rates adjusted to the new trajectory of the federal funds rate.
- Expectations for over seven 25 basis point hikes for 2022 became the consensus.
On March 21st Chairman Powell spoke at a NABE conference and opened the door to a 50 basis point cut at future meetings. He mentioned the Fed’s ability to raise rates beyond the neutral rate (widely recognized at 2.5%), which was a double down from the Fed meeting in the prior week. Investors thought this was the most hawkish language seen in a generation, and called the comments “Volker-like”. Bonds sold off sharply and the 2-year Treasury note reached 2.1% while the U.S. 10-year note topped 2.30%.
By month-end rates stabilized slightly, but expectations for 50 basis point future hikes were the norm. Economic data points, especially inflation data, should see heightened sensitivity as it will drive May Federal reserve meeting projections.
The widely examined yield curve became a hot topic as the U.S. 2s/10s Treasury yield curve flattened and inverted on March 29th for the first time during this cycle. In the past, this has been a fair indicator of an upcoming recession. This highlights that investors don’t believe the FOMC will be able to engineer a “soft landing” and they will tighten rates until the economy breaks (at which time holding longer-dated bonds would be more advantageous).
The Fed may attempt to re-steepen the curve by using the balance sheet aggressively and crimping liquidity by selling longer-dated bonds to the market. This would likely affect the housing market as mortgage rates would continue to rise.
Despite the yield curve inversion, we think it’s important to note the total return of bonds in general when rates are rising. For instance, in March, Treasuries in the 1-3-Year space returned -1.36% (-2.50% year-to-date), and bonds in the 10-30-Year space returned -3.93% (-10.95% year-to-date). The value of a basis point is greater as you go longer out on the curve. This illustrates yield curve wages are small compared to the overall picture of duration management.
Piton has been cautious on inflation and Fed policy within all of our portfolio mandates. As such, we have maintained a strategic short-duration posture in our portfolios.
Please compare returns to comparative fixed income allocations/providers. From our analysis of relative comps, Piton is adding alpha with a lower standard deviation. Active macro-management in the fixed income world is very important at this time.
Our team continues to offer customized portfolios and solutions to meet your needs through all market and interest rate environments. Please let us know how we can help you and your clients, we are here to serve as an extension of your team.