A recurring theme for WisdomTree related to the bond market is that “there is income back in fixed income.” If we have learned anything from the Fed’s historical pace of rate hikes, it’s that U.S. interest rates are now back to levels that haven’t been seen in roughly 15 years or so. This phenomenon has occurred for Treasuries and U.S. investment-grade (IG) corporates, and outside of some of the risk-off periods that have occurred since 2007, the U.S. high-yield (HY) arena is also in a similar position.
Source: Bloomberg, as of 5/30/23. You cannot invest in an index, and past performance does not guarantee future results. Proxy for Investment Grade Corporates is the Bloomberg U.S. Aggregate Corporate Index Yield to worst; and for High Yield Corporates, the Bloomberg U.S. Corporate High Yield Index Yield to worst.
While the current yield levels are not quite back to their 1988–2007 readings, they are visibly above their 2010–2021 postings. In our opinion, the post-great financial crisis world of negative/zero interest rates skewed investors’ perception of where U.S. bond yields typically resided when monetary policy was not being impacted to fight off the harsh effects of global financial and Great Recession crises. Yes, it took that long (and a once-in-a-generation pandemic) before more traditional economic forces like inflation forced central banks, i.e., the Fed, to return interest rates to levels a generation of advisors and investors had not witnessed before.
Source: Bloomberg, as of 5/30/23. Past performance does not guarantee future results.
The H2 2023 outlook for U.S. Treasury (UST) yields will seemingly be a struggle between the “don’t fight the Fed” and “don’t fight the tape” camps. A data-dependent Fed naturally pushes the UST market into that same mode. As a result, volatility will more than likely continue to be heightened, with rates being skewed more to the upside of recent ranges.
On the credit side of the ledger, U.S. IG and HY spreads, shown in figure 21, have remained within the higher bands of trading activity that became evident about a year ago. Both credit arenas appear to have discounted the possibility of slower growth and, arguably, maybe even a modest recession. The trend throughout the prior 12 to 15 months has been one of renewed buying opportunities when spreads increase out to their “wides,” a pattern that could remain in place as long as economic activity doesn’t show signs of significantly deteriorating.
Source: YCharts, 10-year data through 6/2/23. You cannot invest in an index, and past performance does not guarantee future results.
Summary: U.S. money and bond markets will continue to take their cue from the Fed, but uncertainty regarding the timing for potential rate cuts will be a key aspect for trading activity. The inverted yield curve offers no urgency to move out in duration as we would still rather be “late than early to the duration party.” However, reducing an under-weight in duration to the benchmark in deliberate steps should be considered. Within the U.S. credit markets, the increase in yields within HY offers a cushion for investors should spreads widen out from current readings.
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