Fourth Quarter 2009 Fixed Income Market Review
January 15, 2010
Author(s):
Fourth Quarter 2009 Fixed Income Sector Returns (Pre-Tax)*
Fourth Quarter 2009 Fixed Income return per unit of Duration*
*as of 12/31/2009 Source: Barclays Capital
Market Review
In the fourth quarter of 2009, as household spending and income continued to improve and the financial markets pointed towards a sustainable recovery, a high unemployment rate and expectations of higher inflation posed challenges to the economy. Low interest rates, improved liquidity and improved demand from investors resulted in an increased supply of corporate debt during the fourth quarter as companies continued to take the opportunity to replace short-term debt with longer-term paper. Investors continued favoring riskier assets resulting in overall positive returns for most of the non-Treasury sectors in the fourth quarter and high double digit returns for 2009 for high yield credits. As widely expected, the Federal Reserve maintained its target range for the Fed Funds rate to a range of zero to 0.25% at its last meeting of the calendar year on December 16, 2009 and stated that “…economic conditions are likely to warrant exceptionally low levels of federal funds rate for an extended period…”. In a statement following its last meeting, the FOMC shed light on improved market conditions by indicating that “…financial market conditions have become more supportive of economic growth…”. The Committee also indicated that in order to promote a smooth transition in the markets, the Committee is gradually slowing the pace of purchases of agency mortgage-backed securities, and it anticipates that these transactions will be executed by the end of the first quarter of 2010. The expectation of inflationary pressures and a reduced demand for U.S. Treasuries caused the yield curve to steepen, with the spread between the 10 year Treasury and the 2 year Treasury ending at 270 basis points as of December 31, 2009, up from 236 basis points as of September 30, 2009.
Fixed income returns for the fourth quarter ranged from negative 8.46%, posted by the 30-year Treasury, to positive 3.27%, posted by Commercial Mortgage-Backed Securities (“CMBS”). Lower grade and shorter maturity sectors posted the best performance. The broadly followed Barclays Capital U.S. Aggregate Index had a total return of 0.20% for the fourth quarter of 2009. Its yield increased by 13 basis points from 3.55% on September 30, 2009 to 3.68% on December 31, 2009. The 3-month T-Bill Index had a total return of 0.04%, whereas the 2-year Treasury Index had a total return of 0.16% and the 10 year Index had a total return of -3.60%. The 30 year Treasury Index, with a total return of -8.46%, under-performed the 10 year Index by 486 basis points. The yield of the 2 year Treasury Index increased by 18 basis points from 0.96% to 1.14%, the yield on the 10 year Index increased by 53 basis points from 3.31% to 3.84% and the yield on the 30 year Index increased by 59 basis points from 4.05% to 4.64% resulting in steepening of the yield curve. Triple-B corporate credits continued their rally and out-performed triple-A corporate credits in the fourth quarter with a return of 2.06% versus -0.20%, for a difference of 226 basis points. For the calendar year 2009, triple-B credits posted a strong positive return of 27.21% with triple-A credits posting a negative return of 0.06% (a difference of 2,727 basis points). Both the single-A and double-A credit sectors also out-performed the triple-A sector with fourth quarter returns of 0.79% and 0.17%, respectively.
The financial sector had a return of 2.60% in the fourth quarter. Both the industrial and utility sectors underperformed the financial sector with returns of 0.77% and 0.16%, respectively. Mortgage-backed securities (“MBS”) produced a fourth quarter return of 0.57% and the duration of the MBS sector increased from 3.08 years as of September 30 to 3.57 years as of December 31, which contributed to an increase in the duration of the Aggregate Index from 4.43 years to 4.57 years as MBS accounted for 36.8% of the benchmark. In the fourth quarter, the tax-exempt municipal bond market experienced mixed results across the yield curve with shorter maturity municipals outperforming longer maturity municipals. The total returns for the fourth quarter ranged from -2.39%, posted by long (20+ year) municipals, to 0.80%, posted by 3 year municipals. Tax-exempt municipals outperformed Treasuries across all maturities, as 10 year municipals had a total return of -1.27%, whereas 10 year Treasuries had a total return of -3.60% (a difference of 233 basis points); 5 year municipals had a total return of 0.55%, whereas 5 year Treasuries had a return of -0.64% (a difference of 119 basis points).
Past performance is no guarantee of future results. Indices are gross of fees and are not available for direct investment. This material has been prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice or an offer of securities.
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