As much as most would like to forget about 2020, it was a year to remember for the fixed income markets. From the historically aggressive monetary policy of the Federal Reserve, to extreme volatility throughout the fixed income markets due to the pandemic, to a significant change in Fed policy, 2020 was full of surprises for bond investors. But most importantly, it was only the third year in the past decade that the broad bond market performed at or above its historical long-term average. The aggregate U.S. bond market returned a bit over 7% for 2020, close to the 45-year return for the Bloomberg Barclays U.S. Aggregate Bond Index.1
As the global economy shut down due to the pandemic in March, the Fed was quick to act, dropping the Fed Funds rate to a range of 0% – 0.25% and implementing numerous lending programs (including the outright purchase of corporate bonds) in order to flood credit markets with liquidity and keep rates low. As markets adjusted to the reality of COVID-19, spreads widened dramatically in high-yield (junk) bonds, and other lower credit-quality fixed income securities. As the year progressed, these spreads tightened to more normal levels, providing significant total returns across the fixed income spectrum. Bonds across the various types of issues provided total returns of anywhere from 5% to nearly 10%.
However, fixed income markets experienced a lot of volatility along the way. The benchmark 10-Year U.S. Treasury bond started 2020 with a yield of 1.92%, traded as low as 0.54% by March 9th and is trading at 1.13% as of 1/11/21. Another way to think about this is that the 10-Year yield fell by 72% between the first of the year and mid-March, followed by an 109% increase. As the yield curve continues to steepen, our focus is on the risk that higher rates can pose to equity valuations from here.
Inflation is also a focus of ours in 2021. In August, the Fed changed its policy from targeting a 2% inflation rate to an average 2% inflation rate looking back historically. This is a significant shift, as it implies the Fed will be willing to let inflation run higher than 2% for some time due to the muted inflation of the past decade or so. This is an important trend to watch as 2021 unfolds.
1 Source: FactSet