As the second quarter drew to a close, the Treasury curve experienced flattening, with short-term Treasury yields rising while longer Treasury yields declined and the stock market set record highs. The largest movement in Treasury yields was in the longer-maturity securities as yields dropped precipitously. The 30-year Treasury experienced the biggest decline as of 6/25/21, dropping 29.6 bps to 2.117% for the quarter. That decline was followed closely by those of the 10-year and 20-year Treasuries, which dropped 25 bps to 1.493% and 26.7 bps to 2.047%, respectively. The largest increase in yield was in the 3-year Treasury as of 6/25/21, which rose 11.8 bps to 0.467% as the Fed signaled a possible start to raising interest rates over the next year and a half.
At the June FOMC meeting the Fed signaled that the economic landscape had experienced some changes over the second quarter. The most significant change was in policy projections, with the dot plot. Seven of the 18 participants now expect rate hikes in 2022, and the median forecast for the end of 2023 is now up to 50 bps. They also increased their GDP growth estimate by 50 bps to 7%, as well as coming in with an aggressive second half of 2021 unemployment forecast of 4.5%. The news from the FOMC meeting triggered increased flattening of the curve, as seen in the notes on the Treasury market above.
As the Treasury curve flattened, we saw continued tightening in spread securities such as corporates and taxable municipals. As of 6/25/21, the Bloomberg Barclays US Agg Corporate Bond Index had tightened 9 bps to +82 bps, which is the tightest level since 2005. Spreads on taxable municipals also continued to tighten during the quarter, benefiting our strategy. The Bloomberg Barclays Taxable Muni US Agg Index tightened 9 bps to +86 bps. The continued tightening in taxable municipal spreads helped our portfolios as a result of our larger exposure to municipals relative to the benchmark.
During the quarter, we continued shortening durations as long Treasury yields fell and spreads continued to tighten. We used this as an opportunity to take profits while becoming more defensive. With the proceeds of the sales, we are continuing to add more defensive securities to the portfolios, including Treasury floaters and short callable agencies, as we discussed in last quarter’s article. We have lowered our duration target from 4.25–4.75 years to 4.00–4.50 years, as it is still our belief that the long-term trend in Treasury yields will be higher.
Going forward, Cumberland will structure portfolios defensively as the economy further improves. We will look to continue shortening durations while taking a conservative approach to investing portfolios in the current yield environment. Portfolios will maintain an increased weighting in defensive securities, as outlined above, while we look to take profits where we can in securities that have benefited from tighter spreads.
Daniel Himelberger
Portfolio Manager & Analyst – Fixed Income
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