Why corporate bonds reacted to the QE3 exit and GDP surprise

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Dec. 4 2020, Updated 10:52 a.m. ET

Economic releases and corporate bond yields and spreads

As mentioned earlier in this series, the Fed announced its exit from the third round of quantitative easing (or QE3) last week. This would imply lower liquidity for stock and bond markets. There will be higher yields for corporate bonds.

Economic data and earnings released last week. They pointed to an upbeat outlook for the U.S. economy and corporates. The advance estimate for third quarter gross domestic product (or GDP), increased 3.5% quarter-over-quarter. This was higher than expected.

Initial jobless claims were trending to 14-year lows. As a result, high-grade bond yields increased as markets factored in higher inflation expectations and the odds of an increase in rates coming in sooner.

 

Returns on investment-grade bonds 

Bond yields and prices move in opposite directions. Due to the increase in yields last week, returns on investment-grade bonds were negative. The BofA Merrill Lynch U.S. Corp Master Total Return Index Value declined by 0.2% over the week. However, the Index is up by ~7% this year.

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Popular exchange-traded funds (or ETFs) that provide exposure to high-grade corporate bonds—like the iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD), the iShares Core Total U.S. Bond Market ETF (AGG), and the Vanguard Total Bond Market ETF (BND)—were down by ~0.3%, ~0.2%, and ~0.4%, respectively, over the week ending October 31.

Positive economic news usually means higher stock prices. Popular ETFs tracking broad-based stock market indices were up during the week. The SPDR S&P 500 ETF (SPY) and the SPDR Dow Jones Industrial Average (DIA) touched new record highs on Friday as a result of Japan’s expanded stimulus. SPY and DIA were up by 2.7% and 3.4%, respectively, over the week ending October 31.

Demand for U.S. investment-grade debt has been high because of geopolitical tensions overseas. It also benefited from the lower yields brought about by an accommodative monetary policy.

In the next part of the series, we’ll discuss the Fed’s latest monetary policy updates. We’ll also analyze other factors affecting the outlook for investment-grade bond market ETFs.

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