Like Goldilocks tasting the little bear's porridge,
fixed-income investors in the second quarter found the economic
news not too hot, not too cold, but just right!
As a result, investors were as hungry for risk as Goldilocks
was for porridge.
The riskier a taxable category was, the better it did.
Hard-currency emerging markets debt funds led the way, soaring
0.77% in June and 4.74% in Q2, according to preliminary data from
BBB-rated corporate funds rose 0.30% in June and 2.94% in Q2.
High-yield funds gained 0.79% and 2.11% in the month and
Treasury funds gained 2.59% in Q2 despite losing 0.23% in
Treasuries had a tough June due to the improved economic
outlook. Investors increasingly felt comfortable putting their
money to work elsewhere, including stocks.
"Some economic indicators are starting to turn up," said Rick
Raczkowski, co-manager of $1.8 billion Loomis Sayles Core Plus
Bond Fund . "We're seeing healing in labor markets, increased
loan demand, increased loan availability, stronger industrial
production and business confidence. We could see better housing
growth in the second half, especially with the decline in
The yield curve flattened slightly in the quarter as the yield
on two-year notes edged up 3 basis points to 0.469% while the
yield on 10-year notes fell 20 basis points to 2.53%.
"That reflected market perception of the Federal Reserve's
thinking," Raczkowski said. The economy is growing slowly enough
that investors did not expect a change in pace of the tapering in
the Fed's bond buys. Nor did they expect the Fed to speed up the
timetable for raising rates.
Investor buys of longer Treasuries pushed prices up and the
Raczkowski expects a better economy in the second half. And he
does not see inflation rising above the Fed's 2% target.
"The macro environment will continue to be supportive of the
bond market, especially non-Treasury spread products," he
The warming economy is cooling his interest in high-quality
investment-grade bonds in some defensive sectors like food and
During Q2 he owned a bond from Brazil's Braskem, the largest
producer of resins in the Americas.
The bond, which matures July 22, 2041, has a 7.125% coupon and
is rated Baa3 by Moody's.
Its Q2 total return was 9.02% as its yield slipped to 6.89%
from 7.48% at the quarter's start. The comparable Treasury
It benefited from investor sentiment in favor of emerging
markets and strong company fundamentals. It also reflected
outperformance in the 30-year part of the curve.
Tax-exempts posted gains for Q2 despite suffering setbacks in
June in almost every category.
One reason was low new issuance. Peter Hayes, head of the
municipal bonds group at BlackRock, says Q2 issuance left munis
17% below the average pace for the first six months.
Also, munis often track Treasuries. Treasury prices
downtrended from late May through June.
Muni prices should get a boost this month. Issuance is not
scheduled to rise, and many investors will reinvest summer
The key economic indicator that muni investors will be
watching is the jobs report, Hayes said. "If we get 225,000 (new
jobs per month) or higher, the market might view economic growth
as sustainable and we might see a backup (rise) in rates," he
The Detroit bankruptcy is not affecting the broader market, he
But he's concerned about Puerto Rico, whose bonds have sold
off. "That tells us something is going on," he said. Puerto Rico
bonds are widely held, and unlike Detroit debt, the worst case
scenario has not been priced into the Commonwealth's bonds, Hayes
Hayes owned a University of Illinois bond issued to finance
capital improvements at the Urbana-Champaign campus.
The bond, with a 5% coupon, matures April 1, 2044, and has a
call on April 1, 2024, at par. They're rated AA- by S&P.
Its Q2 return was 3.28% as its price to call rose to 108.424
from 104.977. The Barclays muni index gained 2.59%.
The bond benefited from a steepening of the yield curve at the
long end, 20 years and longer, Hayes said.