February Fixed Income Update
- Stubbornly high inflation data resulted in a repricing of the yield curve and a reassessment of the Federal Reserve “Fed” policy expectations during February.
- Rising yields and Fed hike expectations drove negative returns for fixed income asset classes closely tied to interest rates, such as Mortgages, Municipals, and Investment Grade Corporates. (Table 1)
- At the same time, continued signs of economic strength led to better returns across High Yield and Emerging Markets Debt, with yield spreads unchanged or tighter. (Table 1)
- Large cap equities gave back some of January’s gains (S&P -2.4%)1 while technology stocks and small cap held up better.
- High Yield Corporate Default rates remained subdued,1 and the new issue market opened in 2023. (Page 4)
February by the Numbers
Chart 1
Chart 2
Table 1
Sources: ICE Data Services, JP Morgan, Bloomberg, BondBloxx | Data as of 2/28/23
Fixed Income: U.S. Treasuries
- The full Treasury curve repriced higher (Chart 3) last month,with the 3 to 7-year “belly of the curve” showing the greatest yield increases, signaling that investors are worried about inflation longer than just in the very near-term.
- All major price reports for January came in above expectations, including Core Consumer Price Index “CPI” (+5.6%),2 Core Producer Price Index “PPI” (+5.4%),2 and the Fed-watched Personal Consumption Expenditures “PCE” Core Deflator (+4.7%),3 highlighting that lowering inflation to the Fed’s target will take longer than previously thought.
- Meanwhile, there have been no signs of weakness in the labor markets,4signaling that wage cost pressures are unlikely to abate. January unemployment came in at 3.4% and average hourly earnings grew +4.4%, both continuing robust numbers.2
- Fed action expectations rose, with the market now expecting three +25bps rate hikes in 2023. (Chart 4) Two-year break-evens jumped sharply, another sign of inflation expectations.
Chart 3
Chart 4
Table 2
Sources: Bloomberg, BondBloxx | Data as of 2/28/23
Fixed Income: Emerging Markets Debt
- Emerging Market Debt (EMD) sold off in February as they tracked rates, snapping a 4-month run of positive returns. Spreads were mostly unchanged. (Chart 5, Table 3)
- For the year-to-date period, EMD is up about +1%, beating the Treasury market as spreads have tightened. Economic strength continues to surprise on the upside, bolstering prospects for emerging countries, while simultaneously driving Central Bank policy fears. (Table 3)
- For the past six months, both EMD (+1.8%) and US High Yield (+2.4%) have posted strong returns,1 beating Investment Grade and Treasury markets, which have posted negative returns on the back of Fed policy actions and comments. (Table 1)
- Fun Fact: over the past 30 years, Emerging Market bond returns are 0.58 correlated with stocks. This relationship jumped to 0.70 during the last three years.5
Chart 5
Chart 6
Table 3
Sources: JP Morgan, BondBloxx | Data as of 2/28/23
Fixed Income: U.S. High Yield Ratings
- High Yield sold off in February along with rising yields, though did not erase strong gains from January. (Chart 7)
- The CCC sector of High Yield outperformed, showing a positive return on righter spreads, while BB and single-B securities reported negative returns due to greater sensitivity to interest rates. (Chart 7, Table 4)
- Spreads continued to tighten across the majority of High Yield on continued strong economic and employment data. CCC yield spreads vs. Treasuries are now nearly 180 bps tighter than the start of the year, for example (Table 8).
- The High Yield new issue market is running at double the anemic pace of 2022 so far this year, with nearly $40 billion priced in 2023.4
- Fun Fact: The correlation between High Yield and Equity returns is 0.62 (measured monthly over 40-years).5
Chart 7
Chart 8
Table 4
Sources: ICE Data Services, JP Morgan, Bloomberg, BondBloxx | Data as of 2/28/23
Fixed Income: U.S. High Yield Sectors
- All major High Yield industry sectors posted negative returns for February, but all strongly positive year-to-date. (Table 9)
- Consumer Cyclicals led the field with a -0.7% return, while Telecom lagged, falling -2.1% in February. (Chart 9) This pattern is roughly the same for the year-to-date period.
- Even as returns for February were brought down by interest rate moves, yield spreads continued to tighten across much of the High Yield market, led by Consumer Cyclicals. (Chart 10)
- High Yield defaults are running about 2% on a trailing 12-month basis, below the long-term average for the asset class.1
- Fun Fact: The correlation between High Yield and Treasury returns is less than 0.08 (measured monthly over 40-years).5
Chart 9
Chart 10
Table 5
Sources: ICE Data Services, JP Morgan, Bloomberg, BondBloxx | Data as of 2/28/23
Sources
1 JP Morgan | Data as of 2/28/2023
2 Bureau of Labor Statistics | Data as of 2/28/2023
3 Bureau of Economic Analysis | Data as of 2/28/2023
4 Bloomberg | Data as of 2/28/2023
5 BondBloxx | Data as of 2/28/2023
Glossary and Index Definitions
- The Bloomberg U.S. Aggregate Index is a broad-based flagship benchmark that measures the investment grade, US-dollar-denominated, fixed-rate taxable bond market.
- The ICE BofA U.S. High Yield Index tracks the performance of U.S. dollar-denominated, below investment grade-rated corporate debt publicly issued in the U.S. domestic market.
- The ICE BofA Broad Market Index measures the performance of U.S. dollar-denominated, investment grade debt securities, including U.S. Treasury notes and bonds, quasi-government securities, corporate securities, residential and commercial mortgage-backed securities and asset-backed securities.
- The ICE BofA U.S. Corporate Index tracks the performance of U.S. dollar-denominated investment grade rated corporate debt publicly issued in the U.S. domestic market.
- The ICE BofA U.S. Treasury Index tracks the performance of U.S. dollar denominated sovereign debt publicly issued by the U.S. government in its domestic market.
- The ICE BofA Current 10-year U.S. Treasury Index is a one-security index comprised of the most recently issued 10-year U.S. Treasury note.
- The Bloomberg U.S. Treasury Target Duration Indices are a suite of 8 indices designed to target a specific duration using US Treasury securities. The 8 durations targeted are 6 Month, 1 Year, 2 Year, 3 Year, 5 Year, 7 Year, 10 Year and 20 Year.
- The ICE Diversified U.S. Cash Pay High Yield Rating Category Indices contain all securities in the ICE BofA U.S. Cash Pay High Yield Index, broken down by their rating categories: BB1-BB3, B1-B3, and CCC1-CCC3. Index constituents are capitalization-weighted, based on their current amount outstanding.
- The ICE Diversified U.S. Cash Pay High Yield Sector Category Indices contain all securities in the ICE BofA U.S. Cash Pay High Yield Index, broken down by industry including: Industrials; Telecom, Media & Technology; Healthcare; Financial & REIT; Energy; Consumer Cyclicals; Consumer Non-Cyclicals. Index constituents are capitalization-weighted, based on their current amount outstanding.
- The Bloomberg A Corporate Index measures the A-rated, fixed-rate, taxable corporate bond market.
- The Bloomberg BBB Corporate Index measures the BBB-rated, fixed-rate, taxable corporate bond market.
- The Bloomberg Municipal Bond Index covers the USD-denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and prerefunded bonds.
- The JP Morgan EMBI Global Diversified Index tracks total returns for traded external debt instruments in the emerging markets, including U.S. dollar-denominated Brady bonds, loans, and Eurobonds with an outstanding face value of at least $500 million.
- The J.P. Morgan 1-10 Year Emerging Markets Sovereign Index tracks liquid, U.S. dollar emerging market fixed and floating-rate debt instruments issued by sovereign and quasi sovereign entities. The EMBIGDL 1-10 Index is based on the long-established J.P. Morgan EMBI Global Diversified Index and follows it methodology closely, but only includes securities with at least $1 billion in face amount outstanding and average life below 10 years.
- The S&P 500 Index tracks the performance of 500 leading large-cap U.S. equities and covers approximately 80% of available market capitalization.
- The Bloomberg US Mortgage Backed Securities Index tracks fixed-rate agency mortgage backed pass-through securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).
- The NASDAQ Composite Index measures all NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market, including over 2,500 companies, An investment can not be made in an index.
- Credit Spread: the difference in yield between a debt security and its benchmark measured in basis points
- OAS: Option Adjusted Spread. For a bond, the option-adjusted spread is the measurement of the spread between the bond and the underlying government yield curve. For an Index, the average of its constituent security government option-adjusted spreads, weighted by full market value.