Interest Rate Volatility Spikes
Interest rate volatility surged during the quarter as bank failures caused an abrupt repricing to lower yields. The MOVE Index, the bond equivalent to the VIX Index, surged to its highest reading outside the 2008 recession. The two-year Treasury has had quite the ride in recent months.

  • There have been five separate directional changes of at least 50 basis points in less than six months.
  • Two-year Treasury yields fell 89 basis points in two days, the largest since the 1987 stock market collapse.
  • Two-year Treasury yields peaked at 5.07% and then fell 130 basis points in 12 days.

Investment grade and high-yield spreads moved quickly wider. In March, high yield spreads widened more in four days than during any period of the global financial crisis. Only the COVID crisis saw a slightly larger change. Yet, high yield indices ended the month with a positive return of 1.1%.

Despite spreads widening, all sectors had positive monthly returns. This was due to interest rate exposure, which helped cushion the widening in spreads. The high yield index yield-to-worst reached 9.8% last October and ended the month at 8.5%. Despite the risk-off month of March, high yield posted a quarterly return of 3.6%. Investment grade corporate bonds returned 3.5% while U.S. Agencies returned 2.1%.

Everyone Continues to Anticipate the Recession
We once again saw first-hand how risk works. It is the same every time; you don’t see it coming. We anticipate potential outcomes and their impact on portfolio risk. We don’t take excessive risk due to overconfidence in what we “see.” The simple backdrop is that we have clear recession signals that everyone has seen for quite some time. Recession immediately triggers response signals that we were poised to repeat in 2000 and 2008.

Offsetting this is significant de-grossing that has taken place as many have anticipated the recession. The American Association of Individual Investors measures weekly investor optimism toward equities. It just reached its lowest-ever 100-week moving average. The series goes back more than 35 years and equity investors are more pessimistic on a rolling two-year basis than at any other time. Bank of America surveys show portfolio managers are significantly underweight in corporate bonds. Credit spreads and equities are positively correlated, and the consensus outlook is bearish.

You’ve likely heard the saying, “If everyone knows something, then it isn’t worth knowing.” Maybe the recession isn’t worth knowing at this point. History often sides with positioning and negative sentiment as more prominent to forward returns. If this somewhat optimistic approach is realized, it will still be a difficult path. There likely will be more months similar to March but offset with risk-on environments in between. Until it becomes clear that we are in an easing cycle and liquidity will support risk markets going forward, we could be in a back-and-forth posture for quite some time. This is a great environment for fixed income as it generates positive carry that can continually be reinvested. Corporate bonds do well as their excess return compounds amid oscillating spread levels.

Portfolio Positioning
Our strategies are currently near benchmark on duration. We expect to remain here until the cycle plays out. The conflicting data is significant and potential speed and direction of the moves is quite high. It is not a great bet to favor one side at this time. Corporate bond exposure is neutral to slightly above benchmark, which is our minimum for this cycle. We think corporate bonds will fare better in a recessionary environment versus recent history. They will also do quite well in a choppy market environment.

The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.

This content is provided for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and should not be interpreted as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.