Markets experienced volatility in the third quarter of 2020 as COVID-19 and the looming election continued to drive uncertainty regarding an economic rebound. The net result of the volatility left the Treasury market little changed on the quarter, while spreads on investment-grade corporates and taxable municipals continued to grind lower from the peaks set at the end of the first quarter.
As the third quarter ends, the minimal movement in Treasury yields shows a shift to a slightly steeper yield curve, with short-term rates dropping and longer maturities remaining flat to slightly higher in yield for the quarter. The 6-month T-bill experienced the biggest drop in yield as of 9/28/20 as it declined 5.8bps to 0.101%. Other short-term Treasuries also dropped in yield out to 7 years, while the 10yr out to 30yr Treasuries rose slightly. As of 9/28/20, the 10yr Treasury had risen 0.5 bps to 0.662%, and the 30yr rose 0.8 bps to 1.42%.
The September FOMC meeting was the fourth meeting in a row at which the Committee held the target fed funds rate in the 0–0.25% range and signaled that they expect to hold short-term rates lower for longer. With the news of short-term rates remaining low, an argument can be made for a steeper yield curve moving forward. One of the biggest drivers of this argument is the recent uptick in inflation prints, which have temporarily suppressed the need for additional stimulus to the economy from the Fed.
The higher inflation and tightening spreads on investment-grade corporates and taxable municipals has led Cumberland Advisors to adjust our strategy and shorten our durations, as we expect higher rates on longer maturities going forward. At the end of the first quarter and throughout the second quarter we extended our durations to take advantage of spread widening as the pandemic hit the United States. The Bloomberg Barclays US Agg Corporate Bond Index widened to +373 bps as of 3/23/20, and the Bloomberg Barclays Taxable Muni US Agg Index widened to +262 bps as of 3/25/20. Since hitting those highs, they have tightened drastically, with the corporate index tightening 233 bps to +140 bps and the taxable municipal index tightening 102 bps to +160 bps.
We are currently selling some of our longer maturities and taking profits as we become a little more defensive. After shifting our portfolios to mostly spread securities throughout the second quarter, we are now adding some short Treasuries, including Treasury floaters and T-bills. We are also adding a weighting in short agency securities to get portfolio durations down and protect the gains from longer securities that were sold to take advantage of the rally in spread securities.
Going forward, we will be watching how COVID-19 and the presidential election in November shape the US economy. Our view is that once we can put COVID-19 and the election behind us, we will see Treasury yields start to increase on the long end as the yield curve steepens. Our goal is to stay flexible while taking a conservative approach to investing in the face of a pandemic that has created new challenges for the investment management process.
Daniel Himelberger
Portfolio Manager & Fixed Income Analyst
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