THE CORE CONUNDRUM - Guggenheim Partners

SECTION 1
The Core Conundrum
In an environment where the benchmark index is heavily concentrated
in low-yielding government and agency securities, maintaining low
tracking error and pursuing total return targets have seemingly become
contradictory objectives. In the following section, we will discuss how
recent monetary and fiscal policy has created this conundrum for
core fixed-income investors.
Monetary Policy Distorting
Government and Agency Markets
Having reached the limits of conventional monetary
policy, quantitative easing (QE) has become the
preferred tool for U.S. central bankers to keep interest
rates artificially low in hopes of stimulating the
economy. Over the past five years, the total aggregate
assets on the Federal Reserve’s balance sheet
increased by a staggering 225 percent (compared
to 22 percent over the previous five-year period).
Recognizing that the Fed’s asset purchases are
entirely policy-driven and contrary to natural
market dynamics, investors should pause to fully
appreciate the attendant implications. Whenever
there is an uneconomic buyer making large-scale
investment decisions irrespective of price, market
distortions are inevitable.
Artificially low yields have long been the case with
Treasuries, and this distortion is increasingly true
for agency mortgage-backed securities (MBS),
which have been purchased at the rate of $40 billion
per month since the start of QE3 in September
2012. With the start of an additional $45 billion per
month Treasury purchase program beginning in
January 2013, and the Fed’s statement that highly
accommodative monetary policy will continue
at least until specific unemployment or inflation
targets are reached, Treasury and agency MBS
markets are likely to remain distorted throughout
the next several years. Today, these overbought
asset classes currently represent nearly 75 percent
of the Barclays U.S. Aggregate Bond Index.
3 | THE CORE CONUNDRUM GUGGENHEIM PARTNERS