"Risk-Off” Trade Drives Market Action

Yields fell and prices rose across much of the investment-grade fixed income universe last week, as investors reacted cautiously to escalating geopolitical tensions.  The rally in risk-free bonds such as Treasury Notes was orderly and caused only a slight spread widening in riskier sectors such as investment grade corporates.  Overall, performance in the investment-grade bond market, including municipals, corporates and agency mortgages, has been quite strong.  One sector that has reacted in a negative way to global unrest and one that we’ve received questions about recently is high yield bonds.  Junk bonds experienced anoutflow of $7.1 billion last week, which was the fourth consecutive week of outflows and a new weekly record.  Credit spreads have widened and prices have fallen across much of the high yield universe.  We attribute this weakness to investor concern over how riskier sectors will react to Federal Reserve monetary policy normalization.  We have long cautioned that sectors most exposed to an investor base that reached for yield by going downhill in credit quality would see the most volatility when things change.  Based on the recent price action and our expectation for monetary policy to continue to normalize, this call appears to have been warranted and is one that we continue to believe is warranted.