Assessing Volatility and Opportunity in U.S. Fixed Income | Lord Abbett
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Market View

What might contribute to the next potential round of interest-rate volatility?

Read time: 2 minutes

In a new report, “2021 Midyear Investment Outlook,” we encapsulate the views of a panel of Lord Abbett investment leaders on prospects for economies and markets in the second half of 2021. In this excerpt, Kewjin Yuoh, Partner and lead Portfolio Manager for the firm’s taxable fixed-income strategies, discusses the potential for volatility in the U.S. bond market stemming from inflation and U.S. Federal Reserve (Fed) policy uncertainty within his positive, intermediate-term outlook for credit. We urge you to read the full report (available here) or view a replay of a related webinar (registration required).

Fixed-income investors tend to be watchful of potential volatility drivers, especially coming off the year we had in 2020. Inflation concerns and uncertainty over future Fed policy moves, in light of the recent discussion focused on delivering a more inclusive recovery, have the potential to generate volatility. Additional uncertainty stems from the unfamiliar nature of the Fed’s policy directive to pursue flexible, average inflation targets in an environment with potential inflation tailwinds.

The question many investors have pertains to fixed-income valuations in tandem with these risks. Aside from factors that may cause spread widening within select credit industries or rising interest rates generally, over the longer-term, real (inflation-adjusted) yields are the drivers of yield increases, in our view. Currently, the impetus behind the rise in real yields is expanding U.S. economic growth—a scenario that is typically constructive for credit and is the basis for our positive intermediate-term outlook.

Over the last year, record levels of corporate bond issuance have been purposed toward improving capital structures, interest coverage, and available cash on balance sheets, which has also bolstered overall credit quality. Expanding economic growth could further the trend already seen in the U.S. high yield bond market. Based on the credit-quality breakdown of the ICE BofA U.S. High Yield Constrained Index, BB-rated high yield bonds comprised 54% of the index as of the end of May 2021, compared to 35% in 2000 (see Figure 1).

 

Figure 1. Historically High-Quality Ratings Mix for U.S. High Yield

Credit quality breakdown of the ICE BofA U.S. High Yield Constrained Index

Source: ICE BofA U.S. High Yield Constrained Index. Data as of May 31, 2021. The index tracks the performance of U.S. dollar-denominated below-investment-grade corporate debt publicly issued in the U.S. domestic market. Qualifying securities must have a below-investment-grade rating (based on an average of Moody’s, S&P, and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date, a fixed-coupon schedule, and a minimum amount outstanding of $250 million. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Past performance is no guarantee of future results.

 

With economic strength supportive of credit fundamentals, our positive outlook over the intermediate-term favors high yield corporate credits over investment-grade corporate credits that are less vulnerable to a rise in rates, given their shorter duration. Bank loans also offer a potential opportunity to capitalize on the reopening trade while minimizing potential interest-rate risks.

Summing Up

We believe Inflation and rate policy uncertainty can be a potential source of volatility, especially for rate-sensitive bonds. One important consideration, however, is that expanding economic growth helps to promote positive credit fundamentals, such as increase interest coverage and overall balance sheet health. Over the intermediate-term as economic strength persists, shorter-duration credit sectors, such as high yield, and sectors that offer protection against a potential rise in interest rates, such as bank loans, remain a viable source of yield.

 

A Note about Risk: The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk. Credit risk is the risk that debt issuers will become unable to make timely interest payments, and at worst, will fail to repay the principal amount. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income. In addition, bonds are subject to other types of risks, such as call, credit, liquidity, interest-rate, and general market risks. Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes. Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements. Statements concerning financial market trends are based on current market conditions, which will fluctuate.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. All investments involve risks, including the loss of principal invested.

This material is provided for general and educational purposes only. The examples provided are for illustra­tive purposes only and are not indicative of any investor situation.

This Market View may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The credit quality of the securities in a portfolio is assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor's, Moody's, or Fitch, as an indication of an issuer's creditworthiness. Ratings range from ‘AAA’ (highest) to ‘D’ (lowest). Bonds rated ‘BBB’ or above are considered investment grade. Credit ratings ‘BB’ and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer's ability to pay interest and principal on these securities.

basis point (bp) is one one-hundredth of a percentage point.

Spread is the percentage difference in current yields of various classes of fixed-income securities versus Treasury bonds or another benchmark bond measure. 

The ICE BofA U.S. High Yield Constrained Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date, a fixed coupon schedule and a minimum amount outstanding of $250 million.

ICE BofA Index Information:

Source: ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS USE OF THE ICE BofAML INDICES AND RELATED DATA ON AN "AS IS" BASIS, MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE ICE BofAML INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THE USE OF THE FOREGOING, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND LORD, ABBETT & CO. LLC., OR ANY OF ITS PRODUCTS OR SERVICES.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in this Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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