|
6.B. - Page 16 of 41
<br />REDWOOD CITY
<br />QUARTERLY MARKET SUMMARY
<br />SUMMARY
<br />• In Q3, U.S. economic conditions were characterized by: (1) economic indicators improving
<br />at a faster -than -expected pace, yet still trailing pre -virus levels; (2) equity markets
<br />surpassing their February all-time highs before selling off marginally in September; (3)
<br />investment-grade (IG) sector spreads continuing to grind tighter as the Fed reaffirmed its
<br />accommodative monetary policy and unconditional support of financial markets; and (4)
<br />daily COVID-19 cases remaining stubbornly high despite continued containment efforts,
<br />reminding all of its lingering presence.
<br />• The Fed spent Q3 refining its messaging after deploying a wide variety of tools in Q1 and
<br />Q2. At its two meetings over the quarter, the central bank voted to leave the target range
<br />for the federal funds rate unchanged at 0% to 0.25%. At the Fed's annual Economic
<br />Symposium hosted in Jackson Hole, the central bank announced a major policy shift on
<br />inflation and will now seek to achieve inflation that "averages 2% over time," moving away
<br />from the prior point -in -time target approach. Interestingly, the FOMC's updated economic
<br />projections released at its September policy meeting show inflation only reaching 2% in
<br />2023. The new average inflation goal implies that the federal funds target rate may stay at
<br />near 0% beyond 2023 as the Fed can allow faster growth and higher inflation. Given the
<br />better-than-expected economic recovery pace so far, the Fed's updated forward projections
<br />for growth and unemployment improved but still portrayed a drawn-out recovery.
<br />• Shorter -term Treasury yields remained low and range -bound, anchored by the Fed's zero -
<br />interest -rate policy. Longer-term Treasury yields edged higher due to positive economic
<br />news, the Fed's shifting stance, on inflation, and optimism about another potential round of
<br />fiscal stimulus. As a result, Treasury index returns were muted. Meanwhile, IG sector
<br />spreads continued to compress, although at a slower rate than the preceding quarter,
<br />leading to positive excess returns. Diversification, once again, played an important role in
<br />portfolio performance in Q3.
<br />• Although economic activity trails pre -pandemic levels, the strong recovery thus far has
<br />propelled stock market performance and equity indices, both in the U.S. and around the
<br />globe. The S&P returned 8.5% in Q3, following Q2's impressive 20% rebound.
<br />ECONOMIC SNAPSHOT
<br />• The U.S. economy contracted at an annual rate of 31.4% in Q2, following Q1's 5.0%
<br />decline, due to the pandemic -induced economic shutdown. The American consumer,
<br />who accounts for about two-thirds of GDP, was the largest detractor in Q2.
<br />• The labor market continued to improve in Q3 but still has an uphill battle to reach pre -
<br />pandemic levels. The unemployment rate declined to 7.9% in September, from 11.1 % in
<br />June and 14.7% in April, as an additional 3.9 million people became employed over the
<br />quarter. However, total employment remains about 11.2 million less than in February.
<br />Furthermore, the number of permanent job losses rose in Q3 and weekly initial jobless
<br />claims remained stubbornly high, evidence of the headwinds facing future jobs reports.
<br />For the Quarter Ended September 30, 2020
<br />Fixed Income Management
<br />INTEREST RATES
<br />• The U.S. Treasury yield curve remained relatively unchanged over the quarter. Shorter -
<br />dated yields on maturities less than 6 months decreased four bps as they continued
<br />to reset closer to the Fed's zero -interest -rate policy amid less Treasury Bill issuance
<br />compared to Q2. Long-term yields on maturities 10 -years and longer inched only slightly
<br />higher by five bps, largely on the Fed's renewed inflation outlook.
<br />• At quarter -end, the yield on a 3 -month Treasury Bill stood at 0.10%, the 2 -year note was
<br />0.13%, 5- and 10 -year notes were 0.28% and 0.69%, respectively, while the 30 -year
<br />Treasury ended the quarter at 1.46%.
<br />• The combination of lower rates on maturities out to seven years and modest curve
<br />steepening on only the longest maturities resulted in intermediate-term Treasuries
<br />providing the most attractive performance amongst Treasury indices. For example, the
<br />3 -month and 2 -year Constant Maturity U.S. Treasury Indices returned 0.04% and 0.05%,
<br />respectively. Meanwhile, the 5- and 7 -year indices returned 0.18% and 0.40%, and the
<br />10- and 30 -year benchmark notes returned 0.04% and -0.78%, respectively.
<br />SECTOR PERFORMANCE
<br />• Diversification away from Treasuries was again additive to performance in Q3. Momentum
<br />from the retracement of wider spreads at the onset of the pandemic continued in Q3,
<br />albeit at a reduced pace, and led to most IG fixed income sectors generating strongly
<br />positive excess returns relative to similar duration Treasuries.
<br />• Federal agency yield spreads remained wide from a historical perspective, most notably
<br />on maturities three years and longer. Shorter -dated agency yield spreads, on the other
<br />hand, snapped back to pre -pandemic levels. Because of higher yields and immediate
<br />spread tightening after issuance, agency indices generated excess returns, with longer -
<br />dated agencies outperforming shorter maturities.
<br />• The IG corporate sector was a top performer in Q3 as spreads retraced nearly all the
<br />widening experienced earlier in the year. Continued support from the Fed helped to
<br />anchor spreads, as did better-than-expected corporate earnings and robust demand as
<br />investors continued to search for yield in the ultra-low rate environment. Like Q2, longer
<br />duration and lower -quality issuers outperformed shorter- and higher -quality issuers.
<br />• The asset-backed security (ABS) sector was the primary beneficiary of the stronger -than -
<br />expected consumer, as the collateral performance was better-than-expected. As a result,
<br />ABS yield spreads compressed to levels even tighter than at the beginning of the year.
<br />Limited new supply and heightened investor demand was also supportive. Over the
<br />quarter, longer -duration ABS outperformed shorter -duration securities, while auto loan/
<br />lease structures outperformed credit card -backed issues.
<br />• The federal agency mortgage-backed security sector (MBS) continued to experience
<br />elevated prepayments as homeowners took advantage of today's low mortgage rates
<br />to refinance. As a result, the overall sector underperformed similar -duration Treasuries,
<br />After cratering in Q1, U.S. manufacturing and services activity continued to rebound, although a few structures and coupons generated positive excess returns. Within the
<br />with both ISM surveys moving firmly back into expansionary territory. Meanwhile, most entire agency -backed mortgage security sector, commercial MBS (CMBS) was the top
<br />housing market measures, including new home sales, existing home sales, building performer, generating positive excess returns largely due to increased prepayment
<br />permits and mortgage applications, all surged above pre -pandemic levels due to record- protection.
<br />low mortgage rates.
<br />PFM Asset Management LLC 62
<br />
|