Brexit was without a doubt June’s most unsettling news for the fixed-income markets worldwide. While earlier in the month, the Federal Reserve announced its decision not to raise rates, all eyes quickly moved to the news that U.K. would exit the European Union and the implication of such a move.
“June was going along just fine for fixed income, until we got to June 23,” Rob Galusza, fixed-income portfolio manager at Fidelity Management & Research, told IBD. “So with that impact of the Brexit vote, there was obviously more volatility and uncertainty injected into the markets.”
Investors flocked to the safe haven of U.S. Treasuries — one of the few options left for global investors desperately looking for positive yields. Due to the higher demand, bond prices rallied. The yield on the 10-year U.S. Treasury note sank to 1.46% on the news, its lowest level in four years. It ended the month at 1.49%, down from 1.85% at the beginning of June. The yield curve continued its flattening move.
With yields falling, general U.S. Treasury mutual funds rallied 3.84% in June, giving them a gain of 3.70% for the second quarter and 9.38% for the year to date, according to preliminary data from Lipper Inc. Investment-grade funds also did well, with the A- and BBB-rated ones amassing 2.17% and 2.19% in June, respectively. They’re each up 6.79% and 7.47% year to date.
Core bond funds jumped 1.67% in June, 2.32% in the quarter, and 5.02% so far this year. High yield funds also did all right, gaining 0.69% in June, 0.85% in Q2 and 6.53% year to date.
On the shorter end, short U.S. government funds advanced 0.43% in June, while short U.S. Treasury funds rose 0.48%. They’re up a respective 1.11% and 1.33% for the first half of 2016. Treasury inflation protected securities (TIPS) also did well, growing 1.75% in June, 1.63% for Q2 and 5.23% year to date.
On the international front, emerging market local-currency debt funds jumped 5.36% in June, rising 3.2% in Q2, while hard-currency ones advanced 3.1% and 4.68%. They’ve returned a respective 12.52% and 9.43% to investors this year. International income funds jumped 2.49% for a total return of 7.4% in 2016.
Underlying the events, what “we’re beginning to see percolate through is true questions about health and robustness of the global economy,” said Dave Mazza, managing director and head of ETF and mutual fund research at State Street Global Advisors. “What that’s doing is impacting asset-class performance significantly. And it’s causing investors to reassess a significant amount of the assumptions that they have for 2016, and of course, the biggest one being what the path and pace would be of hikes by the (Fed).”
Since the Brexit vote, the market has ratcheted down expectations of a U.S. interest rate hike this year. The fed funds futures now show a very low chance of a rate target increase by September or even December this year.
“Where many people were positioned for interest rates that were trending upwards, they are now seeing them trending downwards,” said Mazza. “And the risk-off sentiment that is permeating across markets today, mostly driven by the news of the U.K. referendum, is further putting pressure on long-dated yields.”
Going forward, Mazza notes that “we’re in an environment of low and slow growth, and return expectations are not going to be met.”
The one area where he has above-consensus expectations is the high-yield market, even though it will come with volatility.
“Because there is such a persistent need for income, we will likely see investors, who are comfortable taking a bit more risk, look at high-coupon asset classes like high yield,” he said. Unless, he says, the economic picture changes in the U.S.
Fidelity’s Galusza still likes the U.S. financial sector, despite some recent volatility. Consumer-related sectors such as auto, food and beverage, tobacco and staples are also on his radar. “They’re not cheap but they’re higher-quality and they’re liquid,” he said.
He’s also very constructive on municipal bonds. That sector keeps performing very well this year. General and insured muni debt funds rose 1.6% in June, putting their returns at 2.80% for Q2 and 4.33% year to date. High-yield muni debt funds jumped 1.98% in June, hoisting their returns for Q2 to 3.79% and year to date to 5.94%. Intermediate muni funds rose 1.34%, while short ones advanced 0.31% last month.
“The demand for munis is very strong, the performance there is very good, they’re rallying in line with Treasuries,” said Galusza. “There isn’t as much supply, and there’s a lot of demand.”
SOURCE: ETFS & FUNDS
