Fixed Income Outlook  |  Q1 2021

Sector views

Fixed Income Team

Sector views

Corporate debt: Investment grade and high yield

Investment-grade corporate bonds outpaced the broad investment-grade fixed-income market, but trailed high-yield corporate credit during the quarter. We have a relatively positive medium-term outlook for corporate credit. While acknowledging the ongoing risks associated with COVID-19, we believe there are factors that will be supportive for the U.S. corporate credit market. These include demand for comparatively higher yields in the face of much lower yields globally. Also, investors are aware that the Fed is prepared to provide further support to the market via its bond purchase facilities if necessary. Reflecting investor demand for risk, spreads on corporate securities continued to tighten during the final three months of 2020. [Spreads are the yield advantage credit-sensitive bonds offer over comparable-maturity U.S. Treasuries. Bond prices rise as spreads tighten and decline as spreads widen.]

Although we expect the ongoing global health crisis to affect the high-yield market, we have a fairly positive intermediate-term outlook for corporate fundamentals and the market's supply-and-demand backdrop. Also, even though high-yield spreads re-tightened following their sizable widening in March, we think valuations remain relatively attractive. Reflecting consistent investor demand for risk, high-yield bonds outpaced high-yield bank loans, investment-grade corporate bonds, and the broad investment-grade fixed-income market for the quarter overall.

Trends in the mortgage market

Within the CMBS market, we believe borrowers with access to capital will continue to make investments in properties that were performing well before the pandemic hampered their revenue streams. As a result, we continue to have conviction in the portfolio's CMBX exposure. [CMBX is a group of tradeable indexes that each reference a basket of 25 CMBS issued in a particular year.] We believe current valuations fairly compensate investors for existing risk levels and provide an attractive risk premium.

Fundamental credit analysis and security selection are particularly important in the current CMBS market environment. While some parts of the CMBS market will likely continue to struggle, there are CMBS backed by what we consider to be strong underlying collateral that have suffered amid widespread fear of the sector. We think many of these bonds represent attractive investment opportunities.

Within residential mortgage credit, we believe the dislocations that occurred in March have been mitigated by U.S. monetary and fiscal policy and the gradual reopening of the economy. Against the backdrop of robust home sales and a rebound in mortgage originations, we continue to find value across numerous segments of the residential mortgage-backed market.

In prepayment-sensitive areas of the market, we continue to find value in agency interest-only [IO] collateralized mortgage obligations and inverse IOs backed by jumbo loans and more seasoned collateral. Prepayment speeds on the mortgages underlying these securities stabilized after rising during the summer. This gave investors greater confidence in their ability to build models that anticipate speeds going forward, even if they remain at higher levels. [Mortgage refinancing and early repayment of outstanding mortgages drives prepayment speeds.] Overall, we view prepayment-related opportunities as attractive sources of diversification for the portfolio.

Risk assets enjoyed strong performance during Q4

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Global financial markets trended higher during the fourth quarter, powered by the emergence of COVID-19 vaccines and continuing stimulus policies.