Market Review as of 12/31/2015

Major categories of U.S. fixed-income securities posted negative returns in the fourth quarter of 2015, as high-grade fixed income declined along with other higher-yielding categories. Market expectations ultimately were confirmed in December, as the U.S. Federal Reserve (the Fed) hiked interest-rates for the first time since 2006. The hike lifted the fed funds target range from 0–0.25% to 0.25–0.50%, however, speculation remains regarding the future pace of interest rate hikes and the effectiveness of existing Fed tools given the unprecedented quantitative easing cycle of the past several years.

Following its policy meeting on December 15–16, the Fed released a statement suggesting that U.S. economic growth has been expanding at a moderate pace, as household spending and business fixed investment continue to increase at solid rates. However, the Fed noted that exports have been soft and that inflation continues to run below the Federal Open Market Committee’s (FOMC) longer-run 2% objective. During the meeting, the Fed decided to raise the targeted fed funds rate by 0.25%, to a target range of 0.25–0.50%, and reiterated that it “expects economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate.”1 Fed policymakers’ median projected estimate for the fed funds stands at 1.4% for the end of 2016, indicating a 1% increase over the course of the year.2

Both government-related securities and credit-sensitive segments of the fixed-income market posted negative returns in the fourth quarter, as the market considered the impact of a less accommodative Fed on fixed-income assets. U.S. Treasuries (as represented by the BofA Merrill Lynch U.S. Treasury Index3) posted a return of -0.93% for the three-month period ended December 31, 2015.  The high-yield bond market (as represented by the BofA Merrill Lynch U.S. High Yield Constrained Index4) posted a return of -2.16% for the quarter. The floating-rate loan market (as represented by the Credit Suisse Leveraged Loan Index5) returned -1.96%, reflecting slightly stronger relative performance against the high-yield bond market. The convertible bond market (as represented by the BofA Merrill Lynch All Convertibles, All Qualities Index6) returned 0.85%, benefiting from an underlying rally in equities, in large part due to expectations for a growing U.S. economy and a general rotation out of fixed-income assets.

Among higher credit-quality securities, investment-grade corporate debt (as represented by the Barclays U.S. Corporate Bond Index7) posted a return of -0.58%. Agency mortgage-backed securities (as represented by the Barclays MBS Index8) returned -0.10%. Commercial MBS (CMBS) (as represented by the Barclays U.S. CMBS Investment Grade Index9) returned -1.32%.

Despite pockets of distress in high-profile issuers such as Illinois, Puerto Rico, and New Jersey, the municipal bond market (as represented by the BofA Merrill Lynch U.S. Municipal Securities Index10) outperformed most notable asset classes and returned 1.72%. Overall creditworthiness in the municipal bond market continues to improve, as most states’ finances experienced rising revenues while maintaining balanced budgets.

Within emerging markets, the major themes remained Chinese volatility and the impact of commodity weakness. However, accommodative central bank policies helped mitigate weakness in commodities and reduced new debt issuance provided technical support for the asset class. Thus, the emerging markets corporate debt asset class (as measured by the JP Morgan Corporate Emerging Markets Bond Index Broad Diversified Index11) returned 0.44%, outperforming most U.S.-centric fixed-income asset classes

U.S. inflation increases in October were largely offset due to a decline in the energy sector during the month of November. However, the Consumer Price Index (CPI)12 for all items, excluding food and energy, increased 0.2% in November, the same increase as in September and October. The overall CPI increased 0.5% over the 12-month period ended November 2015, and remains below the Fed’s target of 2.0%. The CPI, excluding volatile food and energy prices, however, increased slightly from the previous quarter, to 2.0%.13

The U.S. labor market continued to strengthen in the fourth quarter, albeit at a slower pace. The U.S. Bureau of Labor Statistics reported that non-farm payrolls increased by 211,000 in November, slightly below the average monthly gain of 237,000 over the prior 12 months, while the unemployment rate held steady 5.0%.14

High-yield new-issue volume trended lower in the fourth quarter, totaling only $42.3 billion, nearly a 30% decline from the previous quarter, with December’s $4.7 billion marking the lowest monthly total since December 2011. In 2015, high-yield issuance totaled $293 billion, down approximately 18% year-over-year. Institutional loan issuance experienced a second consecutive annual decline, totaling $326 billion, down 30% on a year-over-year basis. J.P. Morgan Securities is forecasting the high-yield default rate to rise, to 3.0%, in 2016, although this is largely due to an expected default rate of approximately 10% in the troubled energy sector. This forecast is based on an expectation that WTI (West Texas Intermediate Oil) averages close to $45 throughout the year. If WTI remains in the mid-$30s, energy defaults would likely increase to 20%, and the overall default rate forecast would increase to 4.5% for 2016. Excluding commodities, J.P. Morgan forecasts high-yield bond and loan-default rates of 1.5% for 2016 and 2017, respectively, both of which are well below their long-term averages of 3.6% and 3.3%, respectively.

Fund Review as of 12/31/2015

The Fund maintained its strategy of investing in short-term, liquid government and government-sponsored enterprise (GSE) securities, including agency discount notes, Treasury notes, repurchase agreements collateralized by Treasury and GSE securities, and overnight cash deposits.

Rates on discount notes with maturities of six months and less issued by the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal Home Loan Banks (FHLBs) rose by approximately 12 basis points, lifting off of historically low levels. Overnight repo rates rose from 0.15% to 0.44%, and the effective fed funds rate increased from its previous range between 0.10% and 0.15%, to nearly 0.40%, following the Federal Reserve’s interest rate hike.

The Fund's yield to maturity at the end of the fourth quarter was 0.26%, compared with 0.12% at the end of the third quarter of 2015. Cash comprised approximately 20% of the portfolio, and was invested in collateralized repurchase agreements that mature at the start of each business day. The average maturity was 52 days at the end of the fourth quarter, nearly unchanged from the average maturity at the end of the third quarter of 2015 and the target maturity profile of the portfolio.

Please refer to under the “Portfolio” tab for a complete list of holdings of the Fund, including the securities discussed above.



The Fed reasserted itself as the major guiding policy force in the fourth quarter, particularly within fixed-income markets. China remains an area of significant concern, as the country has the ability to disrupt global markets, including U.S.-centric fixed-income and equity markets. While the Fed’s liftoff provided some clarity, there still remains uncertainty regarding the pace with which the FOMC will continue to raise rates. Most market participants expect a slow and gradual rise, as has been indicated by Fed language.  However, the effectiveness of the tools at the Fed’s disposal remains a cause for concern, as they seek to normalize policy after unprecedented levels of quantitative easing in recent years. As uncertainty persists regarding the state of the global economy, investors increasingly are calling into question how insulated U.S. growth can remain from the broader global economy still seeking to fully recover from the financial crisis of 2008–09.

Fed policymakers’ median projected estimate for the fed funds rate stands at 1.4% for the end of 2016,2 although market-implied projections indicate a lower rate at the end of 2016.16  The overall market reaction to the Fed’s decision to raise rates in December appeared positive, offering a drastically different experience when compared to the “taper tantrum” of 2013. Investors will likely continue to monitor closely key economic data, with a particular focus on inflation, for an indication that the Fed might have sufficient justification to accelerate its interest rate-tightening cycle. Similarly, investors will be looking for reassurance that if U.S. growth stagnates, the Fed will be willing to slow its progression in order to support the economy.

Contact a Representative