Bonds Have Their Worst Quarter Since The Eighties
In 1980, “The Empire Strikes Back” was still running in movie theaters, the unlucky country occupying Afghanistan was the Soviet Union, and Ted Turner had just launched CNN as the first 24-hour news channel. Prior to Q1 2020, it was also the last time the Bloomberg Barclays U.S. Treasury Index had fallen more than 4.00 percent in a single quarter. The Bloomberg Barclays U.S. Aggregate Bond Index, a common benchmark for core bond strategies, was also down 3.37 percent, marking its worst quarterly return since 1981, when the multi-decade bull market in domestic interest rates began.
There are obvious differences between the early eighties and 2021. Most notably, the 10-Year U.S. Treasury Note yield was in the double digits in 1980-1981, as the Federal Reserve under Paul Volker sought to cut rampant inflation that had plagued the U.S. throughout the 1970s, whereas yields have been rebounding from record lows in 2020-2021. Today’s inflation is also comparatively tame as the domestic economy recovers from the impacts of a modern-day plague, though the Fed under Jerome Powell’s leadership has expressed a desire to let the economy run hot and Congress’ purse strings are loose, which could lead to greater price increases than in recent years.
At any rate, the last year has been a wild ride for the bond markets. Following a vertiginous decline amid the onset of the COVID-19, benchmark U.S. Treasury yields – particularly at intermediate and long maturities – closed a substantial portion of the gap with their pre-pandemic levels. The 10-Year U.S. Treasury Note, which yielded 1.92 percent at the end of 2019 and closed at an all-time low of 0.52 percent last March, ended March 2021 at 1.74 percent, marking the highest level in the last 12 months. The 30-Year Treasury yield tells a similar story, rising sharply from 1.65 percent at the end of 2019 to 2.41 percent at the end of March.
While holding Treasuries has certainly been painful recently, other investment-grade bonds in the Aggregate Index offered few places to hide from Q1’s rout. Investment-grade corporates, for example, fell 4.65 percent largely due to their roughly 1.5 years of additional duration versus the Treasury index at the start of the year. Agency MBS fared somewhat better, only dropping 1.10 percent due to support from the Fed’s quantitative easing program. Short-dated ABS posted a comparatively respectable -0.16 percent total return, but one had to look to high-yield corporates, with their greater equity sensitivity, to find a positive return (0.85 percent).
Many investors will likely experience some level of shock upon seeing results like these from one of their safest asset classes, and invariably some will suspend prudence and sell. On the other hand, the significant divergence in stock and bond returns over the last quarter and trailing twelve months will lead many institutional investors to realign their portfolios with their strategic asset allocations by selling stocks and buying bonds. Time will tell which will have the greater impact. One thing that is certain, however, is that many more market participants will be looking at this allocation in a new light as the economy reopens and the new economic cycle accelerates.
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