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
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.
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