Second Quarter 2008 Fixed Income Market Review
July 14, 2008
Author(s):
Second Quarter 2008 Fixed Income Sector Returns
Second Quarter 2008 Fixed Income Return per Unit of Duration
Skyrocketing energy prices, inflationary threats, worsening credit conditions and softer labor markets roiled the financial markets in the second quarter of 2008. After lowering the target for the federal funds rate by 25 basis points to 2.00% on April 30, 2008, the Federal Reserve held the rate steady ay 2.00% at its subsequent meeting on June 25, 2008. In a statement following its last meeting, the Federal Reserve Open Markets Committee (“FOMC”) indicated that tighter credit conditions and the ongoing housing conditions are likely to weigh on economic growth over the next few quarters. The FOMC also repeated its prior cautionary inflation comments, concluding that “the upside risks to inflation and inflation expectations have increased.” Treasuries underperformed most other fixed income sectors in the second quarter of 2008 in the face of rising inflation and the expectation that the Federal Reserve may increase the federal funds rate this year to contain inflation. The yield curve flattened, reversing its 12 month steepening trend, with the spread between the 10 year Treasury and the 2 year Treasury ending at 135 basis points as of June 30, 2008, down from 182 basis points as of March 31, 2008.
Most sectors of the bond market posted negative returns for the second quarter of 2008, with the exception of T-Bills and triple-B rated corporate bonds, each of which exhibited small positive returns. Higher grade credits and longer maturity Treasuries exhibited the worst absolute returns in the second quarter. The broadly followed Lehman Aggregate Index had a total return of –1.02% for the second quarter of 2008. Its yield increased from 4.51% on March 31, 2008 to 5.07% on June 30, 2008. The 6-month T-Bill Index had a total return of 0.25%, whereas the 2-year Treasury Index had a total return of –1.15% and the 10 year Index had a total return of –3.52%. The 30 year Treasury Index, with a total return of –2.46%, outperformed the 10 year Index. The yield of the 2 year Treasury Index increased by 101 basis points from 1.62% to 2.63%, the yield on the 10 year Index increased by 55 basis points from 3.43% to 3.98% and the yield on the 30 year Index increased by only 22 basis points from 4.31% to 4.53%. Contributing to the relatively poorer performance for the 10 year Treasury versus the 2 year Treasury was its much higher duration of 8.30 years versus 1.93 years for the 2-year Treasury in a rising rate environment. U.S. credits provided a total return of –0.90% for the second quarter. The “credit spread” differential slightly narrowed for triple-B rated securities while higher rated securities widened modestly during the quarter. The triple-A sector had a total return of –1.09%, which was 122 basis points lower than the 0.13% return provided by the triple-B sector. The duration of the MBS sector increased from 2.91 years as of March 31 to 3.81 years as of June 30, which contributed to an increase in the duration of the Aggregate Index from 4.38 years to 4.68 years.
The tax-exempt municipal bond market experienced mixed results in the second quarter with returns ranging from negative 0.81%, posted by 5 year municipals, to positive 2.20%, posted by 20 year municipals. Tax-exempt municipals outperformed Treasuries across all maturities as evidenced by the fact that 10 year municipals had a total return of 0.05%, whereas 10 year Treasuries had a return of –3.52% (a difference of 357 basis points); 5 year municipals had a total return of –0.81%, whereas 5 year Treasuries had a return of –3.11% (a difference of 230 basis points).
Past performance is no guarantee of future results. Indices are not available for direct investment. This material has been prepared using sources of information generally believed to be reliable. No representations can be made as to its accuracy. Opinions represented are subject to change and should not be considered investment advice nor an offer of securities.
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