Insights

SPDR® SSGA Ultra Short Term Bond ETF (ULST) – Q2 2022 Commentary

During the second quarter of 2022, ULST returned -0.35% on both a NAV basis and market price basis.



Performance

During the second quarter, ULST underperformed its benchmark, the Bloomberg US Treasury Bellwether 3-Month Index, largely due to its overweight allocation to investment-grade corporate credit and commercial mortgage-backed securities (CMBS). Improvements in economic activity in the context of COVID-19 led supply chain shortages and Russia’s invasion of Ukraine, which significantly impacted the commodity markets, led to a strong rebound in inflation during the quarter, causing short-term interest rates to rise significantly and investment-grade credit spreads to widen. For example, the yield on the December 2022 Fed Funds Futures contract (a proxy for very short-term interest rates) increased by 91 basis points (bps) during the quarter, producing negative price returns, and Bloomberg Floating Rate Note Index (FRN) spreads widened by 37 bps during the quarter, producing negative price returns that exceeded its carry, versus the fund’s benchmark, while the credit curve steepened, with BBB FRN spreads 48 bps wider versus AAA FRNs and 22 bps wider versus AA FRNs.

Standard Performance

ulst-performance-table-q2-2022

Quarter in Review

During the quarter, the US economy presented an unemployment rate of 3.6% and a headline year-over-year inflation reading of +9.1% (the year-over-year core CPI was +5.9%) to investors and the Fed. In reaction to this combination of cyclically tight labor markets and record inflation, the Fed continued to accelerate its plans to tighten monetary policy by first announcing a 50 bps rate hike in May and then a 75 bps rate hike in June, and it also signaled another jumbo-sized rate hike for the July FOMC meeting. (To put these rate hikes into perspective, the Fed had not raised the Fed Funds rate at 50 bps or 75 bps increments since 1994.) These announcements led to a broad tightening of US financial conditions. For example, during the quarter, the yield on the above-mentioned December 2022 Fed Funds Futures contract increased by 9 1bps, the above-mentioned FRN spread widened 37 bps, the Bloomberg US Credit Index spread widened by 35bps, and the Bloomberg US High Yield Index spread widened by 244 bps, the US stock market ended the quarter down 16%, and the Chicago Board Options Exchange's CBOE Volatility Index (VIX) was up quarter-over-quarter.

In terms of Fed monetary policy, the Fed Funds rate is now in a range of 1.50% — 1.75% and the Fed’s balance sheet declined by roughly $20 billion during the quarter, with reinvestment purchases made directly into US Treasuries and US agency mortgage-backed securities (MBS). The chart below demonstrates the Fed’s more hawkish pivot in rate policy expectations as the market has moved from pricing in 10 rate hikes out to December 2022 last quarter, to roughly 14 rate hikes currently.

Fed Funds Expectations Versus Nominal Fed Funds Rate

ulst-chart-q2-2022

Our fundamental active fixed income investment process has three components: structural, cyclical, and tactical. Our analysis of structural economic growth trends, which includes demographic trends, the trend growth rate of the labor force, and the trend growth rate of productivity suggest to us a US trend growth rate of roughly 2.0%. As a result, our structural analysis suggests that interest rates will remain historically low.

Our analysis of cyclical trends focuses on economic activity momentum as well as policies that can serve to either extend or contract the economic cycle. As mentioned above, the labor market is cyclically tight and inflation is high. Based upon the readings of unemployment and inflation, the Fed has achieved the maximum employment component of its dual mandate and is now confronting a significant inflation problem, which is the primary catalyst for the above-mentioned acceleration of US monetary policy tightening. We see this as a significant headwind to financial conditions and growth for 2022 into 2023. Fiscal policy, which had been very supportive to the economy during the COVID-19 crisis, is on track to become a mild headwind to economic activity in late 2022 as previous fiscal stimulus packages run their course. High mortgage and auto loan rates are starting to have an impact on activity in the consumer space and the expectation is that there’ll be a continued slowing demand for these large expenditure goods. Given the overall tightening of financial conditions, our expectations for private sector investment is modest at best.

Given the magnitude of US policy headwinds, we are positioned below the Fund’s strategic duration risk target of 0.50. The Fund’s duration decreased, from 0.50 to 0.25, quarter-over-quarter. Regarding our asset allocation strategy, we’re maintaining a conservative asset allocation exposure, with a higher than strategic target allocation to government securities and a lower than strategic target allocation to spread product. Our credit allocation to BBB-rated credit is at 24%, which below our long-term strategic exposure for this strategy. The strategy has a 0.9% allocation to BB-rated credit (which is an allocation used primarily for the optimal management of fallen angels). Asset allocation shifts were limited to bringing down the Fund’s exposure to a government money market fund and increasing our exposure to government securities. The Fed’s accelerated tightening of Monetary Policy is likely to serve as a headwind to financial conditions in 2022. Given this outlook, we expect to remain below our strategic risk targets in interest rate and credit risk for the Fund in the near term, leaving the Fund well positioned for opportunities in 2022.

Given the magnitude of US policy headwinds, we are positioned below the fund’s strategic duration risk target of 0.50. The fund’s duration remained at 0.25 years, quarter-over-quarter. Regarding our asset allocation strategy, we’re maintaining a conservative asset allocation exposure, with a higher than strategic target allocation to government securities and a lower than strategic target allocation to spread product. Our credit allocation to BBB-rated credit is at 25%, which is below our long-term strategic exposure for this strategy. The strategy has a 1.1% allocation to BB-rated credit (which is an allocation used primarily for the optimal management of fallen angels). Asset allocation shifts during the quarter were limited to a moderately lower exposure to government securities and moderately higher exposure to industrials and prime collateral ABS. The Fed’s accelerated tightening of monetary policy, in response to cyclically tight labor markets and high inflation, is likely to serve as a headwind to financial conditions in 2022. Given this outlook, we expect to remain below our strategic risk targets in interest rate and credit risk for the fund in the near term, leaving the fund well positioned for opportunities in 2022.

ASSET ALLOCATION

Security Description

Market Value (%)

Index (%)

Treasuries

22.7%

100

Industrial

28.1%

 

Utility

8.0%

 

Financial Institutions

22.6%

 

Asset-Backed Securities

7.9%

 

Commercial MBS

7.1%

 

Futures

0.0%

 

STIF Funds

4.3%

 

Other

-0.6%

 

Total

100.0

100.0

CREDIT ALLOCATION

Credit Rating

Market Value (%)

Index (%)

AAA Rated or above

38.1

100.0

AA Rated

5.3

 

A Rated

29.6

 

BBB Rated

24.9

 

BB Rated

1.1

 

Not Rated

1.0

 

Total

100.0

100.0

Source: State Street Global Advisors, as of June 30, 2022. Asset allocation is a method of diversification that positions assets among major investment categories. Asset allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss.


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