By Matt L. Peden, CFA, Vice President, Investment Officer

The broad bond market, as measured by the Barclays Capital U.S. Aggregate Bond Index (“Aggregate Bond Index”), posted a quarterly return of 1.78%, as all major fixed-income sectors posted positive returns. Over the previous 12 months, the Aggregate Bond Index generated a return of 7.69%. Several macro risks overshadowed the bond market during the first quarter, most notably increasing concerns over certain sovereign credits, such as Greece, and the increased issuance of U.S. Treasuries to fund a mounting fiscal deficit, including funds needed to pay for a newly passed healthcare program. Despite these risks, investors maintained a strong appetite for risk and higher yields, directing their focus on a very accommodative monetary policy and improving prospects for a sustainable economic recovery. This risk appetite led to a robust demand for riskier assets within spread sectors (non-U.S. Treasury sectors), and volatility within the bond market remained relatively low. Demand for riskier assets was a primary driver of the Aggregate Bond Index’s quarterly return.

During the first quarter, the Federal Reserve Bank (“Fed”) maintained the federal funds rate at 0% to 0.25%. At its last Federal Open Market Committee (“FOMC”) held on March 16, 2010, the Fed stated that it “continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period of time.” The Fed’s consistent message of foreseeable low interest rates reflected that the FOMC recognized the sustainability of the economic recovery remained somewhat fragile, and continued accommodation was needed to transition the economy from government spending to one led and driven by the private sector (consumers spending and business investment). Short-term interest rates, which are often anchored to the federal funds rate, remained at historically low levels, placing continued pressure on money market funds' ability to post positive absolute returns.

As of quarter-end, the U.S. Treasury curve remained basically unchanged from the beginning of the year; however, rates moved up sharply in March in response to concerns over high issuance of U.S. Treasuries (high level of supply) and the willingness for investors to continue to finance the government debt at current interest rate levels. The U.S. Treasury yield curve remained steep as the spread between the 2-year U.S. Treasury and the 10-year U.S. Treasury was 281 basis points, compared to 270 basis points at year-end. As a sector, U.S. Treasuries posted a quarterly return of 1.12%, trailing other major sectors during the period. Longer-dated U.S. Treasuries (maturities of 20+ years) were the worst performers within the sector, generating a modest 0.16% return for the quarter. As of quarter-end, U.S. Treasuries were the only major sector within the Aggregate Bond Index to post a negative return on a one-year basis. U.S. Treasury Inflation Linked Securities (“TIPS”) underperformed their nominal counterparts, producing a quarterly return of 0.56%.

With supply/demand pressure in the U.S. Treasury market, the corporate bond market performed very well, posting a quarterly return of 2.30%. As of quarter-end, corporate bonds produced an impressive one-year return of 23.80%. Credit fundamentals, including the accumulation of cash on balance sheets, continued to improve and compared favorably to other fixed-income sectors. Corporate new issuance was met with strong investor demand, and corporate spreads relative to U.S. Treasuries continued to tighten. Within the corporate bond sector, financials were the best performers, producing a strong quarterly return of 2.87%. Within the Aggregate Bond Index, commercial mortgage-backed securities posted the highest quarterly return at 9.10%, while mortgage-backed securities produced a return of 1.54% for the same period. In terms of credit quality, lower quality (such as BBB-rated) names outpaced higher quality (such as AAA-rated) names.

Two important fixed-income sectors not included within the Aggregate Bond Index posted strong quarterly returns. High-yield bonds (defined as below investment grade corporate bonds) generated a quarterly return of 4.62%, buoyed by improving corporate fundamentals and perceived lower default risks. Additionally, emerging market debt securities produced a quarterly return of 3.61%. Emerging markets were elevated by favorable comparison to developed countries and economies that have helped support the global economic recovery.

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GuideStone Funds shares are distributed by BNY Mellon Distributors Inc., a registered broker-dealer and underwriter of the funds, 760 Moore Road, King of Prussia, PA 19406. GuideStone Capital Management, a controlled affiliate of GuideStone Financial Resources, serves as the investment adviser to GuideStone Funds.