Insights

SPDR® SSGA Ultra Short Term Bond ETF (ULST) – Q1 2022 Commentary

During the first quarter of 2022, ULST returned -0.61% on both a NAV and market price basis.



Performance

During the first quarter, ULST underperformed its benchmark largely due to its over-weight allocation to duration, investment grade corporate credit, and Commercial Mortgage-Backed Securities (CMBS). The strong US economy, tight labor market, and unexpectedly high inflation caused the Fed to continue to accelerate their plans for tightening monetary policy, causing short-term interest rates to rise significantly and investment-grade credit spreads to widen modestly during the quarter. For example, the yield on the December 2022 Fed Funds Futures contract (a proxy for very short-term interest rates) increased by 161 basis points (bps) during the quarter, producing negative price returns, and Bloomberg Barclays Floating Rate Note Index (FRN) spreads widened by 21bps during the quarter, producing negative price returns that exceeded its carry, versus the Fund’s benchmark, while the credit curve was mixed, with BBB FRN spreads 14bps wider versus AAA and 5bps tighter versus AA FRNs.

Standard Performance

Standard Performance Table - ULST Q1 2022

Quarter in Review

During the quarter, the strong US economy presented an unemployment rate of 3.6% and a headline year-over-year inflation reading of 8.5% (the year-over-year core CPI was 6.5%) to investors and the Fed. In reaction to this combination of economic activity and inflation, the Fed continued to accelerate their plans to tighten monetary policy by announcing their first rate hike during the quarter, signaled significantly more rate hikes in 2022, and earlier plans to begin shrinking their balance sheet (via quantitative tightening, aka “QT”). These announcements, in combination with Russia’s invasion of Ukraine, led to a tightening of US financial conditions. For example, during the quarter, the yield on the above-mentioned December 2022 Fed Funds Futures contract increased by 161bps, the above-mentioned FRN Index spread widened 21bps, the Bloomberg Barclays US Credit Index spread widened by 21bps, and the Bloomberg Barclays US High Yield Index spread widened by 42bps, the US stock market ended the quarter down 5%, and VIX, a measure of implied volatility for the stock market, was up quarter-over-quarter. In terms of Fed monetary policy, the Fed Funds Rate is now at a range of 0.25% - 0.50% and the Fed’s balance sheet grew by roughly $200 billion during the quarter, with purchases made directly in US Treasury and US Agency Mortgage-Backed Securities (MBS). Fed’s more hawkish pivot in rate policy expectations as the market has moved from pricing in four rate hikes out to December 2022 last quarter, to nearly 10 rate hikes currently – the last time such a large repricing of rate hikes occurred in such a short time span was 1994.

Fed Funds Expectations Versus Nominal Fed Funds Rate

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 – and the potentially negative effects of COVID-19 on each of these factors – 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, economic activity remains above trend and the labor market is tight. Based upon the readings of unemployment and inflation, the Fed has achieved their dual mandate and are now confronting an inflation problem, which is the primary catalyst for the above-mentioned acceleration of US Monetary Policy tightening, which we see as a headwind to financial conditions and growth for 2022 into 2023. Fiscal policy, which has also been very supportive to the economy, is on track to become a mild headwind to economic activity in late 2022, as previous fiscal stimulus packages run their course. Housing continues to be reasonably robust despite mortgage rates that have increased to nearly 5.0% (for a 30-year conforming fixed rate mortgage). Expectations for private sector investment is expected to remain focused upon inventory restocking.

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.

ASSET ALLOCATION

Security Description

Market Value (%)

Index (%)

Treasuries

28.3%

100

Industrial

25.2%

 

Utility

8.4%

 

Financial Institutions

23.4%

 

Asset-Backed Securities

4.5%

 

Commercial MBS

8.4%

 

Futures

0.0%

 

STIF Funds

6.2%

 

Other

-4.4

 

Total

100.0

100.0

CREDIT ALLOCATION

Credit Rating

Market Value (%)

Index (%)

AAA Rated or above

40.6

100.0

AA Rated

5.0

 

A Rated

28.8

 

BBB Rated

23.9

 

BB Rated

0.9

 

Note Rated

0.8

 

Total

100.0

100.0

Source: State Street Global Advisors, as of March 31, 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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