Bonds are Back
February 27, 2023
Jason Gibbons, Investment Director, Asia
After last year’s -16% rout in global bonds, the start of 2023 saw corporate bond spreads tighten and yields fell, driven by the Fed’s openness to pause rates. The positive January performance has since been erased, however, as demand-side pressures mounted worry over a hawkish Fed turn. Yields, especially short-dated, are now attractive enough to cover spread widening, near-term interest rate moves, and gaps in policy easing expectations.
Stubborn inflation and a hawkish Fed took the US 10-year US Treasury yield from 1.5% to 3.6% over the course of 2022. This was the fastest rate hike in 40 years. Bond yields are now more appropriately pricing in a Fed pause in rates and a delay in the start of cutting rates. The market’s expectations on where the Fed pauses are now closely matching that of the Feds, approx. 5.3%.
Fundamentals across bonds have vastly improved over the pandemic. Corporate balance sheets have de-levered and refinanced over the pandemic. Corporate bond spreads widened in 2022 but remains at long-term averages and are unlikely to widen as much as in past recessions. Muni bonds, in a barbell-type approach, have tax equivalent yields near that of treasuries. Muni’s foundation remains solid, only to be swayed by tax loss harvesting in 2022. They saw more % credit upgrades in 2022, than in any prior 10 years, while keeping debt levels constant.
Regardless of the scenario – a soft landing or overshoot – the Fed is likely to quell persistent inflation in the near term and pause rate hikes. Yields can remain rangebound, tied closely to the level of Fed Funds. Aside from attractive government (fixed and floating rate) yields, up-in-quality corporate bonds have an attractive yield vs. any spread widening. Floating rate instruments (removing interest rate risk) remain more attractive than hedging inflation with TIPS. A diversified public and private market bond portfolio, we believe, is now close to an entry-level to provide positive total returns on the year.
Attractive Opportunities: Higher current yield curves (bars) vs. prior month’s yields (dotted lines)
DISCLAIMERS & DEFINITIONS
This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results.
Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.