State Street Global Markets builds indicators of aggregated long-term investor behavior in fixed income markets from a substantial subset of $10 trillion worth of fixed income assets under custody and administration at State Street.1
This captures behavioral trends across tens of thousands of portfolios and is estimated to capture just over 10 percent of outstanding fixed income securities globally.
The second quarter can best be described as a transitional period, as we finally got to some of the major inflection points in the reopening process. While global vaccinations were slow to start, the acceleration in administered shots in the US and UK provided optimism that herd immunity will be an obtainable goal. However, vaccine rollouts were uneven, with the eurozone and Canada quickly overcoming initial hurdles and developed Asia still lagging. Vaccine rollout in the emerging markets (EM) has proven to be an even slower process where inadequate vaccine access has increased the risk of resurgent COVID variants.
Despite these uneven reopenings, inflation readings have surged globally as reopening demand and supply chain disruptions have resulted in some of the biggest price gains seen in decades. While some of these gains can be attributed to the reversal of last year’s collapsing prices, inflation still ran hotter than expected, as reopening categories were in high demand. Most central banks still expect these price surges to be transitory, although it will now likely take longer to see whether their forecasts prove correct. Nonetheless, rising prices have started the normalization discussion for many developed markets, while a few emerging economies have already raised rates to keep prices in check.
After a fairly volatile first quarter that saw yields rise globally, the rates market was mostly rangebound for much of the quarter before rallying to lower yields near quarter end. The prospect of earlier rate hikes in the emerging markets kept investor flows relatively weak in EM sovereigns compared to the developed markets. Stronger US Treasury buying emerged near the start of the quarter, particularly from foreign buyers when yields spiked to their YTD highs. More recently, cross-border demand for Treasuries has waned, although overall demand remains marginally positive. Since the market increasingly expects the Federal Reserve (Fed) to formally begin discussing the tapering process during the third quarter, market stability would require that investors look past shrinking Fed demand as we move into 2022.
Institutional investors have nonetheless continued to reach for yield in credit during the second quarter. Flows have favored high yield, with investors looking past the prospects of policy normalization, higher inflation prints and near-record corporate issuance. More recently, flows have moderated to neutral in both the investment-grade and high yield parts of the US credit markets, while euro credit demand remains strong.
Safety over yield
In many ways, low developed market yields, expectations for a weaker USD and broad reflationary support make it a perfect environment for emerging market debt (EMD). However, this has not enticed real money investors to increase their allocations to EMD this year. As the chart indicates, investors have generally chosen safety over yield, with net buying of developed market sovereign bonds at the expense of emerging market bonds. As our PriceStats® series shows, inflation in emerging markets has far outpaced price gains in advanced economies, forcing rate hikes in several developing countries. Uneven vaccination rates also create greater risk for emerging markets, which threatens positive growth expectations.
Developed and Emerging Market 20-Day Flows
Treasuries still finding broad support
The Fed has signaled that it has started to think about the normalization process, with broad expectations that tapering of asset purchases will be announced before the end of the year. Interestingly, longer-dated Treasury yields have fallen steadily during the second quarter to levels last seen in February, while the curve has also flattened. And while expectations around the timing of the first rate hike have not changed, fewer subsequent rate hikes are now expected. Our investor flows data continue to show broad buying across most Treasury maturities, with shorter-term flows indicating accelerated buying from the intermediate into the longer end of the yield curve.
US Treasuries 5- and 20-Day Flows
Turning neutral on credit
Both US investment-grade and high yield bonds have seen their spreads tighten this year as the overall cost of corporate borrowing fell to all-time low levels. This has prompted record issuance of high yield debt, while investment-grade issuance has trailed last year’s record volumes. So far this year, investors have favored high yield issuers, with the asset class being one of the few bond categories to post a positive return, with spread tightening and coupon payments resulting in low single-digit returns. Our investor behavior reflects this preference, with positive high yield flows for most of the year and generally neutral investment-grade activity. More recently, both credit categories have gravitated toward neutral, with meaningful spread tightening unlikely from here given the overall low level of yields.
US Investment Grade and High Yield Bonds 20-Day Flows
1State Street Form 10-K, as of December 31, 2020. The fixed income flows and holdings indicators produced by State Street Global Markets — the investment, research and trading division of State Street Corporation — are based on aggregated and anonymized custody data provided to it by State Street, in its role as custodian. State Street Global Advisors does not have access to the underlying custody data used to produce the indicators.
A type of investing, usually involving bills, notes, or bonds, for which real return rates or periodic income is received at regular intervals and at reasonably predictable levels. Fixed income can also refer to a budgeting style that is based on fixed pension payments.
An overall increase in the prices of an economy’s goods and services during a given period, translating to a loss in purchasing power per unit of currency. Inflation generally occurs when growth of the money supply outpaces growth of the economy. Central banks attempt to limit inflation, and avoid deflation, in order to keep the economy running smoothly.
The income produced by an investment, typically calculated as the interest received annually divided by the price of the investment. Yield comes from interest-bearing securities, such as bonds and dividend-paying stocks.
The views expressed in this material are the views of State Street Global Advisors through the period ended June 30, 2021, and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for decisions based on, such information and it should not be relied on as such.
Bonds generally present less short-term risk and volatility than stocks but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
Investing in high yield fixed income securities, otherwise known as “junk bonds,” is considered speculative and involves greater risk of loss of principal and interest than investing in investment-grade fixed income securities. These lower-quality debt securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer.
Investments in emerging or developing markets may be more volatile and less liquid than investments in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
Investing involves risk, including the risk of loss of principal.