Fixed Income Commentary – March 2022
Forgettable February
Bond yields rose in February as market expectations of Fed rate hikes gathered steam, but the outbreak of hostilities at the end of the month limited the climb. Earlier in the month, several Fed officials on the more hawkish end of the spectrum expressed the view that a 50 basis point (0.50%, or 50bp) rate hike may be warranted at the March FOMC meeting, which pushed the short end of the Treasury curve higher. In addition to higher yields on government bonds, risk spreads (the compensation in yield that investors demand for accepting various risks) moved wider on non-government bonds during the month, pushing overall bond yields higher. As a result, the total return for the broad market as measured by the Bloomberg U.S. Intermediate Aggregate Bond Index was -0.78% for February. Meanwhile, total return for the municipal sector as measured by the Bloomberg Municipal Bond Index was -0.36%, demonstrating how municipal bonds can be a diversifier during difficult times.
This recent turn of events is surely making the Fed wish they had started raising rates a long time ago, but here we are. With oil prices now rising further and the threat of more supply disruptions, particularly for commodities exported by Russia and Ukraine, inflationary pressure is likely accelerating. This means the Fed has little ability to alter its stance toward tightening monetary policy, at least not without losing substantial credibility in the process. That said, we do believe a more consensus-style move of 25 basis points is likely in March rather than the 50bp favored by some on the FOMC. Beyond that, we believe each Fed meeting this year will likely see 25 basis point rate hikes, barring a major escalation in global tension or significant disruption in financial conditions.
While it may be frustrating to find negative price changes on bonds in your portfolio, keep in mind this transition to a higher yield regime will allow both existing and future investments to earn higher yields.
Heading in to 2022, we did not believe corporate bond yield spreads would widen based on strong earnings, solid (albeit slowing) growth momentum, and a generally favorable backdrop of good behavior in many sectors of the market. By “good behavior,” we are referring to paying down debt, avoiding debt-financed stock buybacks, and other similar gestures that signify a certain resolve by corporate management to pay attention to bondholders. Year-to-date, spreads have slowly leaked wider due to the above-mentioned re-pricing of expected more-rapid Fed actions and now the Russian invasion. We do not believe much further widening is likely. If we’re right, that should bode well for prospective performance from the credit sector. Regardless of what happens, we advise being patient with bonds since total return over longer periods of time is what matters to investors, not short-term price movements, and income earned over time can outstrip short-term price changes.
As noted above, not all sectors of the market performed poorly in February: municipal bonds were a bright spot. Relative to a year ago, municipal bond yields are more attractive (based on ratios of municipal-to-Treasury bond yields) and credit quality is generally better than a year ago thanks to federal dollars that have flowed to the municipal sector and the solid recovery in most tax revenue streams.
What about the economy? Recent reports paint a mostly favorable picture:
- Robust retail sales which demonstrate that consumers remain eager to return to normal activity and are intent on spending money.
- Both ISM surveys, Manufacturing and Services, point to continued expansion and solid momentum.
- The stronger-than-expected nonfarm payroll report (reflecting January hiring) is expected to be followed by another strong report on March 4 thanks to diminishing Omicron cases and the removal of many pandemic-related restrictions.
The one data series that has come in weaker recently is consumer confidence, which we hold little stock in as a barometer of economic activity since it is prone to all kinds of other extraneous concerns clouding the picture.
As for the Russia-Ukraine conflict, cyber threats are a concern along with higher agricultural commodity prices, some higher transportation costs, and of course higher energy costs (particularly for Europe). There is a great deal of uncertainty as this piece is being written which, in the early hours of March, is causing a flight-to-quality bid for Treasuries (sending prices up and yields lower). Until some kind of resolution becomes apparent, we expect the conflict will dominate market developments for both equity and bonds. News events are evolving rapidly, but at this time we do not believe any of our corporate bond client holdings have any significant exposure to Russia.
As difficult as it is to watch the unfolding crisis in Ukraine, we are encouraged by the solid unity being displayed by most other nations and the actions taken to isolate the Russian government. The global economy does face some risks from this development as noted above, but the overall impact should be minimal and the extraordinary stimulus measures of the last couple of years are still paying dividends.
We are grateful for the continued confidence you place in all of us at Maple Capital Management.
Important Disclosures
Maple Capital Management, Inc. (MCM) is an independent SEC Registered Investment Advisor with offices in Montpelier, Vermont and Atlanta, Georgia.
This commentary reflects the views of MCM and should not be considered to be investment or financial advice. MCM does not warranty these views and will not update this communication after the date of publication. Any mention of specific securities is done for illustrative purposes and the securities mentioned may or may not be held in client accounts. No assumption or assurance should be taken that securities mentioned will be safe or profitable investments.
For further information, please contact Steven Killoran at 1-802-229-2838 or at [email protected] For further information about Maple Capital, including a copy of our informational brochure, please visit our website at www.maplecapital.com.
Index Definitions
The Bloomberg US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).
The Bloomberg Intermediate US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market with less than 10 years to maturity. The securitized sector is wholly inluded. The index includes Treasuries, government-related and corporate securities, MBS, ABS and CMBS..
The Bloomberg US Treasury Index measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury. Treasury bills are excluded by the maturity constraint, but are part of a separate Short Treasury Index. STRIPS are excluded from the index because their inclusion would result in double-counting.
The Bloomberg US Credit Index measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government related bond markets. It is composed of the US Corporate Index and a non-corporate component that includes foreign agencies, sovereigns, supranationals and local authorities.
The Bloomberg US Mortgage Backed Securities (MBS) Index tracks fixed-rate agency mortgage backed pass-through securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon and vintage.
The Bloomberg US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Bloomberg EM country definition, are excluded.
The Bloomberg U.S. Municipal Index covers the USD-denominated long-term tax exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and prerefunded bonds.