September 2022 | Fixed Income Markets Review
U.S. Treasury rates across the yield curve were drifting higher throughout the month in anticipation of the Federal Reserve raising the Fed Funds rate. The Federal Open Market Committee (FOMC) chaired by Jay Powell has been exceptionally transparent in communicating their resolve to lower inflation.
Nevertheless, the announcement of a 75 basis point increase in the Fed Funds rate on September 21st pushed rates higher as the market held out hope of a more gradual increase. What is unique about this current cycle is the combination of magnitude and speed of rate increases. For example, the 2-year Treasury finished September at a yield of 4.20% which represents an increase of 3.93% off the 52-week low of 27 basis points reached in early October 2021. This yield change on a 2-year Treasury ranks in the 3rd percentile of 52-week change going back to June 1976. The implication of such a significant and fast change in yields is the perception of the influence rate changes will have on business activity changing more rapidly than the actual impact on the economy so far. This widening gap in perception versus reality helps explain the equity like volatility bonds have experienced in 2022. On the credit side, investment grade spreads held steady in September and in line with the longer term average over the past seven years. Spreads below investment grade widened in September and are above the average of the past seven years reflecting the increased risk of an economic recession. International government yields rose in sympathy with U.S. Treasury yields as the Federal Reserve is arguably the leader in monetary policy tightening seen globally with few exceptions. Correlations between U.S. and international government yields are currently well above 2021 levels and reflects the fact inflation is a global issue.
The relationship between short and long interest rates is an important barometer of forward economic activity and is one of the components of the Conference Board Index of Leading Economic Indicators. For example, excluding the pandemic driven recession in early 2020, the past three economic recessions were preceded by an inversion of the 2- and 10-year Treasury. These inversions lasted on average 52 weeks while the current inversion is only 13 weeks long. However, because of the speed at which short rates changed in the current cycle the level of inversion now exceeds the average of the past three cycles. The pace at which this inversion has developed is suggestive of a decline in economic activity without the average lag of previous cycles. On the positive side, the possibility of a recession pulled forward more quickly than previous inversions of the yield curve would imply a faster deceleration of inflation and a subsequent decline in yields along the curve. The table below highlights the previous three recessions, duration, maximum inversion and the 52 week change in yields for 2-year Treasuries. Interest rates across the curve declined significantly one year out from the maximum inversion in the cycle. It appears reasonable to expect rates to fall as fast as they rose once progress on inflation convinces the Fed to allow the glide path on a slower economy to develop without additional rate increases.
In summary, fixed income investors have experienced equity-like volatility during 2022 and September offered no relief from rising rates pushing bond prices lower. Actions by the Federal Reserve have been aggressive and their resolve to bring inflation down is risking a downturn in the economy. Bond yields will follow inflation and the economy lower and opportunities to earn attractive risk adjusted returns in fixed income is rising as yields reach multiyear highs. We are gradually extending maturities in portfolios while keeping risk to bond benchmarks below average until we believe the Federal Reserve is closer to the end of restrictive monetary policy.
Notes & Disclosures
Index Returns – all shown in US dollars
All returns shown trailing 9/30/2022 for the period indicated. “YTD” refers to the total return as of prior-year end, while the other returns are annualized. 3-month and annualized returns are shown for:
- The Barclay’s US Aggregate Index, a broad-based unmanaged bond index that is generally considered to be representative of the performance of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
- The ICE BofAML Emerging Markets Sovereign Bond Index is a subset of The BofA Merrill Lynch World Sovereign Bond Index excluding all securities with a country of risk that is a member of the FX G10, all Western European countries, and territories of the U.S. and Western European countries. The FX G10 includes all Euro members, the U.S., Japan, the U.K., Canada, Australia, New Zealand, Switzerland, Norway, and Sweden.
- The Bloomberg Barclays Global Aggregate Index, which measures global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.
- The S&P Global Developed Sovereign Bond index includes local-currency denominated debt publicly issued by governments in their domestic markets.
- S&P Eurozone Developed Sovereign Bond – seeks to measure the performance of Eurozone government bonds.
- The S&P Pan-Europe Developed Sovereign Bond Index is a comprehensive, market-value-weighted index designed to track the performance of local currency-denominated securities publicly issued by Denmark, Norway, Sweden, Switzerland, the U.K. and developed countries in the Eurozone for their domestic markets.
- ICE BofAML Emerging Markets Sovereign Bond – tracks the performance of US dollar (USD) and Euro denominated emerging markets non-sovereign debt publicly issued within the major domestic and Eurobond markets.
- The Bloomberg Barclay’s US Corporate Bond Index (AA), which measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD denominated securities publicly issued by US and non-US industrial, utility and financial issuers.
- The Bloomberg Barclay’s US Corporate High Yield Index, which covers the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market.
- Bloomberg Barclay’s Global Aggregate Securitized- US Mortgage-Backed Securities, which is a component of the Bloomberg Barclay’s US Aggregate Index and measures investment grade mortgage backed pass-through securities of GNMA, FNMA, and FHLMC.
- Bloomberg Barclay’s Global Aggregate Securitized- US Asset-Backed Securities, which is a component of the Bloomberg Barclay’s US Aggregate Index and includes the pass-throughs, bullets, and controlled amortization structures of only the senior class of ABS issues.
- The Blomberg Barclay’s US Floating Rate Notes (<5 Yr) Index, measures the performance of U.S dollar-dominated, investment grade floating rate notes with maturities less than 5 years.
- The Bloomberg Barclay’s Municipal Bond Index, which measures investment grade, tax-exempt bonds with a maturity of at least one year.
- The S&P/ LSTA Leveraged Loan Index is designed to reflect the performance of the largest facilities in the leveraged loan market.
An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance to certain asset classes. Index performance used throughout is intended to illustrate historical market trends and performance. Indexes are managed and do not incur investment management fees. An investor is unable to invest in an index. Their performance does not reflect the expenses associated with the management of an actual portfolio. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. All investing involves risk including loss of principal. Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market. Past performance is no guarantee of future results.
Key Rates are shown for US Treasuries and London Interbank Offered Rate (LIBOR), the interest rate at which banks offer to lend funds (wholesale money) to one another in the international interbank market. LIBOR is a key benchmark rate that reflects how much it costs banks to borrow from each other. “Current” refers to the percentage rate as of 6/30/2018, while the rates of change are stated in basis points.
Credit Spreads shown comprise the Option-Adjusted Spread of the indices indicated, versus the US 10-Year Treasury Yield. “Current” refers to the spread as of 6/30/2018, while the rates of change are stated in basis points.
Key Indicators correspond to various macro-economic and rate-related data points that we consider impactful to fixed income markets.
- 2s10s (bps)/ 10 Yr vs 2 Yr Treasury Spread, which measures the difference between yields on 10-Year Treasury Constant Maturity Securities and 2-Year Treasury Constant Maturity Securities.
- West Texas Intermediate, which is an oil benchmark and the underlying asset in the New York Mercantile Exchange’s oil futures contract.
- Core Consumer Price Index, which measures the consumer price index excluding food and energy prices. Shown as of the prior month-end.
- Breakeven Inflation: 5 Yr %/ bps, which uses a moving 30-day average of the 5-Year Treasury Constant Maturity Securities and 5-Year Treasury Inflation–Indexed Constant Maturity Securities to derive expected inflation.
- Breakeven Inflation: 10 Yr %/ bps, which uses a moving 30-day average of the 10-Year Treasury Constant Maturity Securities and 10-Year Treasury Inflation–Indexed Constant Maturity Securities to derive expected inflation.
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