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Categories
Fixed Income
Long duration credit update for the third quarter of 2021
Greg Garrett
Investment Director


Despite periods of volatility, credit spreads and U.S. Treasury yields ended the quarter little changed. Mixed economic data, rising COVID-19 infections and Federal Reserve policy statements were all in focus for investors. The tragic increase of COVID-19 cases in the U.S. and elsewhere dampened consumer sentiment and appeared to have a negative impact on investors’ appetite for risk. Fed Chairman Jerome Powell confirmed signals from earlier communications that the Fed was likely to begin tapering asset purchases by the end of the year, and the Fed signaled via the dot plot that interest rate hikes are likely to begin in 2022.


U.S. long investment-grade bonds

Treasury yields rose and long bond spreads widened slightly

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 October 1, 2020, through September 30, 2021. The chart shows a significant narrowing in the option-adjusted spread to 122 basis points from 188 basis points over the one-year period despite a 5 basis point widening in the third quarter of 2021. Yield to worst fell to 2.78% from 3.08% during the third quarter and from 3.05% a year earlier. The 10-year and 30-year U.S. Treasury yields both rose in the third quarter. The 10-year ended at 1.52%, up from 1.45% at the end of the second quarter and 0.68% a year earlier. The 30-year ended at 2.08%, up from 2.06% at the end of the second quarter and 1.45% a year earlier.

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

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

Against this backdrop, the Capital Group Long Duration Credit Composite outpaced the benchmark Bloomberg U.S. Long Credit Index on a gross of fees basis but lagged net of highest management fees. For the representative portfolio, positive contributions from security selection and sector allocation outweighed the negative impact of curve and duration positioning.


Despite the unusual nature of the COVID-19 shock and the policy response, the tension in markets is being driven by the usual forces of valuations, economic fundamentals and the path of monetary policy. For investment-grade credit, spreads are near historically low levels while the duration of the index is close to all-time highs and investment-grade corporate leverage is elevated. However, we are likely nearing the end of unrestrained policy accommodation, and economic growth is likely to be trending lower in the next two years. The portfolio managers have focused on owning a mix of credits where the fundamentals continue to support further spread tightening while also looking to transition into more highly rated credits where there is little cost to making the shift.



Greg Garrett is an investment director with 34 years of industry experience (as of 12/31/21). He holds a bachelor’s degree in finance from the University of Arizona.


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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.

 

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The Bloomberg 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.

 

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