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Focus on Shorter-Duration Credit Exposure

Christopher Brown, Jr., CFA, Portfolio Manager

To implement relatively defensive positioning while still generating yield, we focus on areas with the potential to better withstand a resumption in volatility. We favor allocations to shorter-duration bonds in some sectors with credit risk with structurally attractive risk/return profiles.

The Federal Reserve pivoted to a dovish stance in early 2019, acknowledging that economic and financial conditions have weakened both in the U.S. and abroad. It appears that the central bank will leave interest rates at their current level at least through June. While the central bank's shift has helped quell market volatility, we see the potential for more spikes in volatility given global growth concerns and tighter financial conditions.

In order to implement relatively defensive portfolio positioning while still generating yield, we are focusing on certain areas of the market that have the potential to better withstand a resumption in volatility. We favor allocations to shorter-duration bonds in some sectors with credit risk with structurally attractive risk/return profiles. These includes asset-backed securities and dollar-denominated emerging markets debt.

When analyzing sectors, we look at the amount of widening in credit spreads that would offset the extra income generated from those spreads over the course of one year—this is the break-even threshold. Then we compare the standard deviation of credit spreads to the break-even level to gauge the likelihood that they will exceed the break-even threshold.

For example, in short-term emerging market corporate debt, our analysis shows that the recent one-year standard deviation of spreads is 29 basis points. Because this is less than the break-even level, it provides a cushion until the break-even level is reached if we experience the same level of spread volatility that we did over the past 12 months. In contrast, for the broad U.S. investment-grade corporate sector, the standard deviation of spreads exceeds the break-even threshold.

We are carefully watching for signals that could change our outlook. If the economy unexpectedly slides into a recession, the short duration of our positions will limit exposure to credit risk. On the other hand, if stronger-than expected economic
numbers push the Fed off the sidelines to raise rates, an additional advantage of exposure to shorter-duration credit sectors is their lower price sensitivity to interest rate increases.

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T. Rowe Price ("TRP") claims compliance with the Global Investment Performance Standards (GIPS®). TRP has been independently verified for the twenty one- year period ended June 30, 2017 by KPMG LLP. The verification report is available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm's policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation.

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