Fixed Income Perspectives - It’s Not Too Quiet Anymore — Volatility Returns

Matt Toms

Matt Toms, CFA

Chief Investment Officer, Fixed Income

Our 2018 outlook video (below) noted the risk of resurgent market volatility – we think now it's here to stay. Yet, global growth is strong and we expect the Federal Reserve to normalize interest rates cautiously. We favor selling into strength rather than buying on weakness, remaining modestly overweight spread assets.

In our 2018 outlook, we argued that market conditions were likely to lead to a return of volatility. As the saying goes, be careful what you wish for — volatility has returned in a big way. Though equities made headlines, warning signs first emerged in the fixed income market. In December, as the U.S. dollar continued to weaken amid rising energy prices, the 10-year inflation breakeven rate — the difference between nominal and inflation-adjusted Treasury yields — started to increase. Interest rate volatility, which had been declining for more than a year, soon followed suit. This set the stage for the market’s reaction to the strong February 2 payroll report. Volatility accelerated on fears that inflation would rapidly pick up steam, prompting a more aggressive policy stance from the Federal Reserve.

While we saw pockets of turbulence in high yield and emerging market debt, recent volatility was not a credit spread event — it was primarily driven by interest-rate volatility and large swings in short-term equity positions. Years of historically low and largely range-bound interest rates created complacency. The recent rate volatility is a reminder of the fixed income market’s power to send shockwaves across broader capital markets and the economy. We will be paying close attention to the 10-year yield. We think a near-term move to 3% is likely, and that an acceleration through 3%, while unlikely, would intensify volatility. Nonetheless, we believe that yields above 3% represent attractive value and might adjust our tactical positioning to capitalize on what we would view as an opportunity.

Volatility has returned and we believe it is here to stay, however, conditions are only returning to normal following last year’s prolonged, unusual absence. The reappearance of volatility does not change our outlook for strong global growth and a cautious pace of interest rate normalization and balance-sheet reduction from the Fed. We continue to favor selling into strength in spread assets rather than buying on weakness. We remain modestly overweight spread assets, favoring collateralized loan obligations and non-agency residential mortgage-backed securities.

Spreads, Returns and Yields

Spreads, Returns and Yields

Source: Bloomberg, JPMorgan, Standard & Poor’s. All spreads are to U.S. Treasurys and are option-adjusted except for emerging markets, which are nominal. All returns are total returns including dividends, expressed as percentages, in U.S. dollars.

Voya Investment Management’s fixed income strategies cover a broad range of maturities, sectors and instruments, giving investors wide latitude to create a new portfolio structure or complement an existing one. We offer investment strategies across the yield curve and credit spectrum, as well as in specialized disciplines that focus on individual market sectors. We build portfolios one bond at a time, with a critical review of each security by experienced fixed income managers. As of March 31, 2016, Voya Investment Management managed $129 billion in fixed income strategies in the United States.

Past Performance does not guarantee future results.

This commentary has been prepared by Voya Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults, (5) changes in laws and regulations, and (6) changes in the policies of governments and/or regulatory authorities.

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