2014 proved to be an unexpectedly volatile year for bond investors. As the year began, we saw research reports from every major Wall Street broker-dealer calling for higher interest rates and, in some cases, a bursting of the so-called “bond bubble” that (according to some) has been forming over the past 30+ years. What transpired was something quite different. Longer-term rates fell sharply while short-term rates were mostly unchanged. This dramatic flattening of the yield curve came despite a steadily improving domestic economy, the strongest employment numbers in 15 years and a Federal Reserve that began to publically discuss tightening monetary policy.
So why did interest rates fall despite an abundance of good news that historically causes them to rise? In financial markets, the events and trends that few predict tend to have the largest impact. In 2014, those events emerged in the form of European and Japanese Central Banks failing, despite their best efforts, to avoid the imminent danger of recession and deflation. Weakness in these developed market economies, coupled with geopolitical tensions around the world, caused a classic “flight to safety” trade as global investors sought the safety of U.S. dollar denominated assets. This is clearly illustrated by the performance of the U.S. Dollar during 2014 – see chart below. These developments led to positive performance for our client portfolios, with our Short, Intermediate and Long Duration strategies generating after-fee returns at or above inflation.