Market review
Global fixed income markets generated negative total returns during the fourth quarter ending December 31, 2024 (Q4), as measured by the Bloomberg Global Aggregate Index hedged to US$. The U.S Federal Reserve (the Fed) and the results of the U.S. presidential elections were the key events that drove markets in Q4.
Global economic data once again diverged during Q4. The U.S. economy expanded at a faster-than-expected pace thanks to strong consumer spending and export growth. In the U.S., inflation accelerated as shelter costs rose. Euro’s zone inflation also accelerated and unemployment remained at record lows across most countries. UK’s inflation was elevated in Q4, but the rise in services prices held steady, offering the Bank of England (BOE) a little bit of relief. Both New Zealand and Australia saw their Q3 GDP growth fall short of market expectations. Japan’s inflation accelerated on reduced energy subsidies. China’s consumer prices dropped and producer price deflation also deepened.
Developed market (DM) sovereign yields climbed during Q4, led by the U.S. and UK. Outside Europe, investors pared back their expectations for rate cuts following slow progress in containing inflation. The path to policy normalization continued to look different across various countries and regions. According to market pricing, the Fed and BOE are expected to cut rates by about a half point by the end of 2025, while the European Central Bank (ECB) is still wrestling with its target. The Bank of Canada and Swiss National Bank both delivered jumbo rate cuts while Norway’s central bank kept rates on hold and revised down projected rate cuts. The Bank of Japan skipped a rate hike in December as policymakers preferred to tread cautiously amid uncertainty over U.S. President Donald Trump’s economic plans. Central banks’ easing cycles diverged across emerging market economies. Brazil’s central bank raised rates by a greater-than-expected 100 basis points in December and warned of an extended rate-hiking cycle should inflation expectations worsen.
Performance
As of the end of Q4, Sun Life Wellington Opportunistic Fixed Income Private Pool series F (the Fund) generated a return of -4.4% in Q4. The blended benchmark for the Fund posted a three-month return of 1.3% over the same period.
Attribution
Many of the portfolio’s key themes came under pressure as global sovereign yields climbed, the US$ strengthened relative to other currencies, and spreads continued to move tighter across credit sectors during Q4. The Fund realized negative total return contributions from the three components of the portfolio during the period: strategic sector, relative value, and tactical themes.
Strategic sector positions generated negative returns in Q4, led by negative contributions from the emerging market (EM) opportunities and activist governments themes. The portfolio’s overweight in EM local debt detracted from performance, as the US$ strengthened further after the results of the U.S. election. Exposure to Brazil, Hungary, and Colombia were detractors within the EM local theme. The Fund’s exposure to inflation-linked bonds within the activist governments theme was a headwind to performance. The theme generated a negative total return despite outperforming U.S. treasuries and other nominal bonds as break even pricing for inflation rose.
The portfolio’s relative value allocations affected a bit of performance in Q4. The Fund is tactically long duration toward macro rates in October, which hurt performance as markets priced in a Republican sweep within the U.S. Within opportunistic currency, a long EM foreign currency position weighed on performance.
Tactical strategies detracted from performance during Q4, mainly driven by tactical exposure to agency mortgages and U.S. treasuries.
Positioning and outlook
Our sub-advisor Wellington Management Canada (Wellington) views the following as dislocations in fixed income markets today:
- U.S. forward real yields are close to 3%, a level not seen since the early 2000s.
- The yield differential between forward rate pricing between the Fed and the ECB are at historic extremes.
- Agency mortgage spreads relative to U.S. corporate spreads are close to their widest level since the early 1990s.
- Japanese 30-year rates are higher than in China for the first time ever.
- There is a historic gap between EM real yields and U.S. high yield and inflation-adjusted yields.
- U.S. long corporate spreads are at their tightest level since the late 1990s.
- Interest rate differentials have narrowed considerably with the Fed cutting rates by 100 basis points in 2024 and yet the US$ is approaching its highest level since 2021.
- Investment-grade EM external debt spreads are at similar levels in the mid-2000s despite weak currency performance.
These are all extreme pricings that Wellington is looking to take advantage of during 2025. Wellington expects markets to be more volatile in 2025 than in 2024, given the policy uncertainty from the incoming Trump administration.
Rates
The Fund increased its aggregate duration in Q4 by 0.6 years, mostly through the addition of agency mortgages within the tactical portion. Agency mortgage spreads are at a historic high relative to credit and have outperformed since the U.S. election, as interest rate volatility subsided. The Fund also views inflation-linked bonds favourably, and the portfolio has a duration of about 2.3 years on these assets.
Credit
Wellington thinks the market is fully pricing in a goldilocks economic scenario of robust growth with low inflation. It also thinks the market has assigned very little weight to other possible economic scenarios. While the Fund is short credit, the sub-advisor is not envisioning a dramatic slowdown in growth, but a return to a more normal spread volatility environment. The Fund thinks select DM and EM local government bond yields offer attractive value.
Currency
Wellington thinks the US$ is very elevated against other currencies and can face downward pressure in the medium term.