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Capital Ideas

Investment insights from Capital Group

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Bonds
Long duration credit update for the second quarter of 2021
Greg Garrett
Investment Director

Long-term interest rates declined during the second quarter as bond investors shifted their focus from improving U.S. economic growth to a somewhat hawkish change in tone at the Federal Reserve, which brought forward its rate hike forecast to 2023. The Fed’s preferred measure of inflation, the core personal consumption expenditures (PCE) deflator, reached 3.4% in May. Supply-side constraints and base effects have driven the figure to an elevated level. Still, even if transitory in nature, inflation has likely met the precondition for Fed action under its average inflation targeting policy. On the other hand, employment, while improving, has yet to fully recover.


U.S. long investment-grade bonds

Yields declined as spreads narrowed further

Chart shows the option-adjusted spread and yield to worst for U.S. long investment-grade bonds, along with 10-year and 30-year U.S. Treasury yields. Data shown are from July 1, 2020, through June 30, 2021. The chart shows a significant decline in the option-adjusted spread to 117 basis points from 197 basis points over the full period, including a decline of 8 basis points in the second quarter of 2021. Yield to worst fell to 3.08% from 3.45% during the second quarter and from 3.14% a year earlier. The 10-year and 30-year U.S. Treasury yields both fell in the second quarter. The 10-year ended at 1.45%, down from 1.74% at the start of the second quarter but up from 0.69% a year earlier. The 30-year ended at 2.06%, down from 2.41% at the end of the first quarter but up from 1.43% a year earlier.

Option-adjusted spread and yield to worst calculated for the Bloomberg Barclays Long U.S. Corporate Index as of June 30, 2021.

Sources: Bloomberg Index Services Ltd., Refinitiv Datastream. As of June 30, 2021.

Against this backdrop, the Capital Group Long Duration Credit Composite outpaced the benchmark Bloomberg Barclays U.S. Long Credit Index on a gross-of-fees basis, but lagged net of highest management fees. Curve positioning contributed to relative results, while sector and issuer selection were modest detractors. The off-benchmark position in U.S. Treasuries was a detractor in terms of sector selection. Issuer selection benefited from exposures in the energy sector.


We continue to hold a mix of credits across the investment-grade ratings spectrum. This includes more highly rated issuers in areas such as technology and banking and lower-rated companies in energy (pipelines), tobacco and pharmaceuticals. During the second quarter, this mix of credits kept pace with the index as spreads tightened. While we remain constructive on the economic outlook, we believe that we have built a portfolio that is underweight credit with enough dry powder to help protect on the downside should spreads widen.



Greg Garrett is an investment director with 33 years of industry experience (as of 12/31/20). He holds a bachelor’s degree in finance from the University of Arizona.


This investment strategy update and related material are designed for use solely by Qualified Purchasers, institutional investors and consultants.

The return of principal for bond portfolios and for portfolios with significant underlying bond holdings is not guaranteed. Investments are subject to the same interest rate, inflation and credit risks associated with the underlying bond holdings.

Bloomberg® is a trademark of Bloomberg Finance L.P. (collectively with its affiliates, “Bloomberg”). Barclays® is a trademark of BarclaysBank Plc (collectively with its affiliates, “Barclays”), used under license. Neither Bloomberg nor Barclays approves or endorses this material, guarantees the accuracy or completeness of any information herein and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

Bloomberg Barclays U.S. Long Credit Index is a market-value-weighted index that tracks the total return results of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and quality requirements, with maturities of 10 years or more. To qualify, bonds must be SEC-registered and must be an investment-grade security. This index is unmanaged, and its results include reinvested distributions but do not reflect the effect of sales charges, account fees, expenses or U.S. federal income taxes.

Market indexes are unmanaged and, therefore, have no expenses. Investors cannot invest directly in an index.

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