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By Dave Sekera, CFA | 10-11-2016 03:00 PM

Core Bonds Rise in Third Quarter

U.S. Treasury rates rose last quarter as safe-haven demand waned, but tighter credit spreads more than offset the impact of rising rates.

Dave Sekera: During the third quarter, the fixed-income markets quickly shook off uncertainty driven by the U.K. vote to exit the EU at the end of June. Returns in the third quarter, however, have been suppressed (and in some cases resulted in declines) as interest rates on U.S. Treasury bonds have risen off their lows as the flight to quality demand diminished. Yet those fixed-income sectors that trade at a spread over Treasuries have overcome rising interest rates and have generated gains as credit spreads tightened more than enough to offset the impact of those rising rates.

The Morningstar Core Bond Index, our broadest measure of the fixed-income universe, rose by about 0.5% in the third quarter. Gains were mainly driven by tightening credit spreads and secondarily aided by the amount of yield carry.

Within the corporate credit markets, tighter credit spreads led to a 1.5% increase in the Morningstar Corporate Bond Index. In the Morningstar Eurobond Corporate Index, as credit spreads tightened, that index rose by 1.8% in the third quarter. As part of its asset purchase program, the ECB began buying corporate bonds earlier this year. These purchases effectively remove supply of corporate fixed-income securities from the public markets and creates new cash that must then be reinvested. As this cash is then reinvested, this action is bolstering the prices of European corporate bonds and thus helping to push corporate credit spreads tighter.

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