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The First Quarter in Bond Funds

Rising interest rates unsettle bond markets.

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The new year brought mostly good news regarding a potential return to normalcy for economies, which largely left fixed-income markets worse for wear in the first quarter of 2021. The introduction of the $1.9 trillion U.S. fiscal stimulus package and the ongoing coronavirus vaccine rollout boosted expectations for economic growth and higher inflation, both of which caused interest rates to spike and the U.S. Treasury yield curve to steepen over the quarter. Inflation, in particular, spooked bond investors as rising prices erode the value of coupon payments.

The jump in rates spelled trouble for most fixed-income sectors. For the most part, all but the highest-yielding and least rate-sensitive bond sectors sold off as investors stretched for yield and cut exposure to rising rates. The Bloomberg Barclays U.S. Aggregate Bond Index, a proxy for typical U.S. core bond exposure, fell 3.4% for the quarter. Ultimately, most fixed-income Morningstar Categories lost ground in the first quarter of 2021. Long government funds trailed the pack with an average fall of 12.8%, while floating-rate bank-loan funds led the way with an average gain of 1.5%.

Sam Kulahan does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.