Market Sector Update
- Brexit - or the United Kingdom’s decision
to leave the European Union (EU) - was the
most significant event in the quarter. It
opens up major new pathways for political
change, market reactions and central bank
actions that hadn’t been considered.
- Interest rates fell at every major maturity
point in the quarter. Longer maturity
bonds fell the most, with 30-year Treasury
yields falling over 30 basis points (bps).
Long term yields have fallen nearly 75
bps since the beginning of the year.
- Corporate bond and other nongovernment
bond spreads narrowed as
the markets recovered from the firstquarter
correction. Strong demand from
U.S. institutional and retail investors,
along with the European Central Bank’s
(ECB) bond buying programs continue to
provide steady buying.
- As European bond yields headed back
toward record low levels, they dragged
U.S. bond yields with them. The Brexit
vote exacerbated the move lower in
yields, as it is sure to be accompanied by
central banks boosting monetary policy
measures to support the U.K. and Europe
during the breakup.
- Discussion of further rate increases in the
U.S. Federal Reserve Funds (Fed) rate
were dashed because of Brexit and the
potential for fallout in other European
countries. U.S. Fed officials increasingly
take into account global macro factors in
setting interest rates in the U.S.
- Excess returns for most non-government
bond sectors were positive in the quarter
despite the late quarter setback, which
caused spreads to widen in the last week
of the month.
- We added to the Fund’s corporate bond
exposure during the quarter. In particular
we found value in new and secondary
bonds of electric utility and
communications companies. These
sectors are primarily domestic and
consumer-focused and we expect these
sectors will perform better, relative to other
sectors that are more cyclical and
internationally exposed. We reduced
exposure to the banking sector due to
concerns about the impact on profitability
in a low and declining interest rate
- We reduced exposure to agency
mortgage-backed securities, since falling
rates could cause prepayment speeds to
increase on residential mortgages and
lead to underperformance in the sector.
- We added exposure to longer dated
Treasuries and corporates, as we believe
the downward pressure on yields will
- Politics will become more important to
markets than the economy in the near term.
The EU can’t afford another of the
remaining three key members to leave and
expect to keep the union or the currency
- We expect the Bank of England to lower
short term rates and to see more
quantitative easing by the European
Central Bank and Bank of Japan. Investors
don’t think the Fed will raise interest rates
before 2017 at this point. While this may
be a passionate reaction to recent events,
we believe that a Fed rate hike is off the
table for the remainder of this year.
- U.S. bond yields could go even lower.
While long-term U.S. yields are already
near all-time lows, the U.S. market looks
attractive compared to negative yields in
Europe and Asia. Corporate bond
spreads, while immediately rising in
reaction to the Brexit vote, are likely to
narrow in the medium term. European and
Japanese investors are likely to return to
the safety and yield of the U.S. bond
market over the coming quarters as their
markets offer little if any positive-yielding
bonds. Despite very low yields it is hard
not to be bullish on U.S. bonds.
- Despite the anticipated market reactions,
we don’t view Brexit as a catastrophic
event for markets. The biggest risk is
whether this vote reignites broader
concerns over the political commitment of
France and Italy to remain in the EU. Brexit
could serve to accelerate concerns over a
potential breakup of the union and the
end of the euro, should another key
member country consider leaving.
The opinions expressed in this commentary are those of the Fund’s managers and are current through June 30, 2016. The managers’ views are subject to change at any time based on market and other conditions,
and no forecasts can be guaranteed. Past performance is not a guarantee of future results.
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