Strong Third-Quarter Returns in Fixed-Income Market

Dave Sekera: The fixed-income market generated relatively strong returns in the third quarter driven mainly by the continued decrease in interest rates, which pushed bond prices higher across the board.

In the U.S. Treasury bond market, the overall yield curve declined, but the curve also flattened as interest rates in the longer end of the curve fell further than that of the shorter end. In the short end of the curve, the 2-year declined by only 13 basis points to 1.62%, whereas in the longer end, the 10-year declined 35 basis points to 1.66%, close to its multiyear lows.

As a result, the Morningstar Core Bond Index, our broadest measure of the fixed-income universe, rose by 2.28%, well in excess of the yield carry it generated over the quarter. Underlying the broader index, the short-term index rose a little under 1%, and the intermediate index rose a little over 1%, while with its long duration, the long-term index outperformed with a 5.5% return.

Among corporate bonds, the investment-grade bond market outperformed the high-yield market this past quarter as investment-grade bonds generally have a longer duration than that of the high yield. As a result, the Morningstar Corporate Bond Index, which is our proxy for the investment-grade market, rose 3%, whereas the ICE BofA Merrill Lynch High Yield Index only rose 1.25%.

After tightening earlier this year, the corporate credit spreads ended the third quarter close to where they began. The average credit spread in the investment-grade market was unchanged at a spread of 119 basis points over Treasuries. The high-yield market only tightened 5 basis points to a spread of 402 basis points over Treasuries.

Although emerging markets have generated robust returns year to date, economic weakness in Asia and the strong dollar combined to form a strong headwind throughout the third quarter. The Morningstar Emerging Market Composite Index rose almost 1.4%; however, there was a wide distribution of performance across the underlying components. The Emerging Market Corporate Bond Index rose by almost 2.5%, which was partially offset by a loss of 0.2% in the Emerging Market Sovereign Index. With its high correlation to economic activity in Asia, the Emerging Market High Yield Index was the worst performer among our indexes this past quarter, posting a 1.30% loss.