1. The rumor of bonds’ demise is
greatly exaggerated… again
Before the most recent iteration of the Greek/eurozone drama and the Chinese stock market drop at the end of
the second quarter, the emerging narrative was that bonds were finally experiencing the losses that many had
been predicting for years. Dramatic headlines proclaimed the demise of the bond. Examples included a May
13th commentary headline in The Telegraph that blared “Worst bond crash in almost 30 years” and a June 3rd
Bloomberg headline “[European Central Bank President Mario] Draghi Says Volatility Here to Stay as Global Bond
Rout Deepens.”The Telegraph article highlighted “losses over the past three months have reached $1.2 trillion.”
The magnitude of these numbers is somewhat shocking until put into the context that the total value of global
bond markets is in the vicinity of $45 trillion. The ‘rout’ then is still short of a 3% decline.
Though headlines have been deceptive, it is fair to observe there has been a meaningful move in bond and
U.S. Treasuries in particular. From the January 30th low point of 1.64% for 10-year Treasury yields, rates rose
over 50% to a high of 2.48% on June 10th before closing the quarter at 2.35%. Though only an 18 basis point
move from year-end, the over 80 basis point range for trading represents meaningful volatility against the
beginning of the year’s starting point.
How did we get there?
The increase in U.S. Treasury and global bond yields in the second quarter corresponded with an increase off
of all-time lows in German yields from a closing yield of 0.075% on April 20. At one point, €2.8 trillion out of
the approximately €5 trillion eurozone government-bond market was trading with negative yields according
to Bank of America Merrill Lynch. Other second quarter oddities included three-month Euribor (euro interbank
offered rate), the rate at which banks in Europe lend to each other, falling into negative territory and Spain
issuing three-month bills with negative yields, which represented a remarkable contrast to 2011 when it was
considered to be at risk of losing access to debt markets.
Negative yields are a somewhat mind-bending concept. While partially explainable in the context of deflation,
the explanation is incomplete as cash would offer a better real return in a deflationary environment. Growth
expectations were extremely low and inflation expectations were negative, which drove some element of
the downward pressure on yields. The larger factor, though, was the quantitative easing (QE) program by the
European Central Bank (ECB). With the proverbial 800-pound (360 kilogram) gorilla in the room conducting
€60 billion of monthly purchases designed to push down interest rates in Europe, the anticipation of ECB
purchases drove yields below 0%.
Taplin, Canida &
Habacht (TCH)
is an institutional fixed
income boutique within
The Bank of Montreal and
part of the BMO Global
Asset Management group.
TCH manages over $10
billion of assets and is a
subadvisor for multiple
open-end mutual funds. We
are dedicated to investing
on behalf of our clients
and servicing them to the
highest standards. For more
information about TCH,
please visit tchinc.com.
Fixed Income
Insights
Asset Management Third Quarter 2015

2. Unsurprising surprises
The second quarter was filled with unusual and somewhat
contradictory events in global markets: all-time lows for German
Bunds, followed by an increase of yields by an order of magnitude;
a new step forward in European integration – the ECB’s QE program,
once considered off-limits – paired with increased speculation on the
exit of a member country from the common currency.
The July 5th Greek referendum on the creditor terms of the proposed
bailout resulted in a resounding “no” from the Greek populace. While
a new round of bailouts appears to have been agreed upon, the
solution is likely temporary and the political brinksmanship from both
sides brought the potential exit of Greece from the eurozone close
to reality. The exit of a member state would undermine the famous
2012 promise of Mario Draghi that “the ECB is ready to do whatever
it takes to preserve the euro… believe me, it will be enough.” Fiat
currency, being backed by nothing but the creditability of the issuer,
faces a significant challenge when uncertainty is introduced.
Further, to the extent that risk premia rise in Europe, the cost of
capital in Europe will be higher, offsetting some of the benefit of the
ECB’s extraordinary efforts to improve the real economy via monetary
policy. The Greek situation continues to develop at the time of
writing, though given past iterations of eurozone crises, this may be
true no matter when a piece is written.
Recent sharp declines in Chinese equity markets of over 25% after
a doubling over the past year may represent more of a challenge
globally than turbulence out of Greece. Often viewed as the marginal
buyer of commodities, the fall in Chinese equities and perception of a
slowing economy have already impacted oil markets. The last decline
in oil in the second half of 2014 had broader implications for volatility
and was highly correlated with an increase in U.S. credit spreads. In
response to a slowing economy and the recent fall in equity markets,
the People’s Bank of China (PBOC) has cut interest rates four times
since November, joining the group of global central banks easing
monetary policy.
China and commodity prices (January – July 2015)
Thomson Reuters/Core Commodity CRB Commodity Index (Right Axis)
2000
2500
3000
3500
4000
4500
5000
5500
Jul 15Jun 15May 15Apr 15Mar 15Feb 15Jan 15
205
210
215
220
225
230
235Shanghai Stock Exchange Composite Index (Left Axis)
Source: Bloomberg L.P.
Global easing
Though the Bank of Japan (BOJ) and now the ECB are attempting to
create their own versions of the American central bank policy, not all
QE is created equal. There are enough differences in the programs
and the regions to suggest they will play out differently. The Fed’s
version of QE aims (it hasn’t unwound yet) to keep interest rates low
in the U.S. to support interest rate sensitive areas of the economy and
change the risk/reward equation in investors’ minds, shifting them to
more risk seeking activity. In the United States, equity ownership is
ingrained in the culture. By contrast, Europe is generally considered a
‘debt culture’. While the U.S. QE was designed as a change in degree,
the European version is designed as a change in kind. Draghi’s goals
were far more ambitious than Bernanke’s and now Yellen’s. Draghi is
looking for QE to provide the cover for European countries to engage
in the painful structural reform to be more competitive in global
economies. Abenomics, which has professed similarly ambitious
aims, has yet to noticeably transform Japanese culture, suggesting
the 19-month ECB plan may face difficulties in its larger goals, even if
some of the growth and inflation targets are reached.
10-year U.S. Treasury yield (January 2007 – July 2015)
0
1
2
3
4
5
6 Percent
Jan07
May07
Aug07
Jan08
May08
Sep08
Dec08
May09
Sep09
Dec09
May10
Sep10
Dec10
May11
Sep11
Jan12
May12
Aug12
Jan13
May13
Sep13
Jan14
May14
Sep14
Jan15
QE1
End
QE3
End
QE2
End
QE2
Begins
QE3
Begins
QE1
Begins
Sources: Bloomberg L.P.; TCH, LLC
In the second quarter, as European deflation fears receded and
European growth improved, European interest rates began to rise. In
part, Europe’s growth benefited from euro weakening, while the U.S.
experienced a negative first quarter of GDP growth (-0.2%), partly
due to the dollar strengthening. At this nascent stage of the ECB’s
program, it is premature to judge the outcome on yields, but even
more so it is certainly too early to judge the outcome of structural
reform. If the events in Greece are any indication, the painful
restructuring may be more painful than hoped for.
While Europe and Japan struggle with the use of monetary policy
to impact significant structural and cultural changes, the discussion
in the U.S. remains around when the Fed may raise the fed funds
rate. Janet Yellen said at a March 27, 2015 conference that “the
economy’s equilibrium real federal funds rate—that is, the real rate
consistent with the economy achieving maximum employment
and price stability over the medium term—is currently quite low
by historical standards.” We view the Fed as likely to take a “risk
management approach” to monetary policy—erring on the side of
being accommodative, as they view their tools for fighting inflation
as more potent than their equivalent tools for fighting a recession.
That this year’s increase in long U.S. Treasury yields has had little
impact on short rates seems to show that the market is currently
viewing the Fed as patient as well.

3. Looking forward
Conclusions
Relying on mean-reversion heuristics, as market pundits have done
since the end of the recession, has led to spurious conclusions such as
declaring bonds dead… over and over and over again. The current global
economic environment—where trillions of dollars are necessary to keep
economies afloat, a major global currency’s viability is questioned, a
significant emerging market attempts to manage its own ‘soft landing’
while simultaneously being the driving force behind global commodity
prices, developed nations demographics impede growth and innovation
rather than spur it—is not one where interest rates can afford to quickly
“normalize” to historical levels. A different heuristic may be better suited
than mean-reversion for projecting the markets: don’t fight the Fed… and
the ECB and the BOJ.
Global corporate debt yields (January 2010 – June 2015)
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
Apr15
Jan15
Oct14
Jul14
Apr14
Jan14
Oct13
Jul13
Apr13
Jan13
Oct12
Jul12
Apr12
Jan12
Oct11
Jul11
Apr11
Jan11
Oct10
Jul10
Apr10
Jan10
US Investment Grade
EUR Investment Grade
JPN Investment Grade
Percent
Sources: Bloomberg L.P.; TCH, LLC
While a seeming strengthening European economy pulled global
yields higher, the possible exit of Greece from the eurozone reminded
investors of the role of fixed income as a defensive asset in a diversified
portfolio. Credit widening at the same time as increasing yields in the
second quarter have created an opportunity within investment grade
fixed income for overall yields not seen in some time. Credit curves
seem too steep in our estimation, which presents an opportunity within
fixed income. The recent volatility has also left dislocations in its wake,
presenting further opportunities for security selection.
Portfolio positioning
Interest rates / duration: Expect continued rate volatility; remain
neutral and barbelled; current term structure reflects slower expected
pace of Fed rate hikes and lower terminal point for hikes
Treasuries: Underweight, favoring non-government sectors instead;
favor nominal Treasuries over inflation-hedged Treasuries (TIPS)
Credit: Spread curves appear too steep, particularly in industrials,
which presents attractive total return opportunities; U.S. credit should
benefit from relative U.S. strength, global uncertainty, yet higher
yields in U.S. versus other developed markets
Mortgages: Liquidity profile remains attractive for Agency mortgage-
backed-securities (MBS), especially as liquidity has declined in
other sectors. Sector should be supported by limited supply of new
issuance, but offers limited total return expectations
High yield (HY) and emerging markets (EM): Select bottom-up
opportunities persist in HY, but macro concerns and valuations
temper outlook; current yield advantage of EM appropriately
compensates investors for the risk

4. All investments involve risk, including the possible loss of principal.
Keep in mind that as interest rates rise, prices for bonds with fixed interest rates may fall. This may have an adverse effect on a portfolio.
Foreign investing involves special risks due to factors such as increased volatility, currency fluctuation and political uncertainties. High yield bond funds may have higher yields and are subject to greater credit, market
and interest rate risk than higher-rated fixed-income securities. Keep in mind that as interest rates rise, prices for bonds with fixed interest rates may fall. This may have an adverse effect on a Fund’s portfolio.
Investments cannot be made in an index.
This presentation may contain targeted returns and forward-looking statements. “Forward-looking statements,” can be identified by the use of forward-looking terminology such as “may”, “should”, “expect”,
“anticipate”, “outlook”, “project”, “estimate”, “intend”, “continue” or“believe” or the negatives thereof, or variations thereon, or other comparable terminology. Investors are cautioned not to place undue
reliance on such returns and statements, as actual returns and results could differ materially due to various risks and uncertainties. This material does not constitute investment advice. It does not have regard
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