Bonds Commentary

Rally On Perceived FOMC Pivot Overdone

August 2022

July proved profitable for fixed income investors with the Bloomberg U.S. Aggregate (Agg) Bond index turning out a 1.8% monthly gain, while credit-sensitive indices fared even better. The longer duration investment-grade Bloomberg Corporate index and the riskier/higher yielding but shorter duration Bloomberg U.S. Corporate High Yield index rallied 2.6% and 5.7%, respectively, on the month. After the yield on the 10-year U.S. Treasury peaked at 3.5% on June 14, the Agg rallied 5.3% through the end of July as market participants ratcheted down expectations for Fed funds rate hikes, going so far as to bake in rate cuts beginning in early 2023. While directionally July’s rally in Treasuries and corporates makes sense given the decline in commodity prices, the magnitude of the move appears extreme, and yields may be poised to reverse higher given that the market is likely misreading the Fed’s intentions.

Market participants took FOMC Chair Jerome Powell’s post-meeting comments in late July as a dovish pivot, and Fed officials were out in full force in early August to push back on that interpretation and talk down the prospect of a near-term policy about-face. With the 2-year U.S. Treasury yield at 3.22% and the 10-year yield at 2.84% as we close out the first week of August, the short end of the yield curve now holds more appeal from a relative value perspective, driven by our view that a near-term Fed pivot is unlikely. As a result, we expect an upward bias to rates on long-dated U.S. Treasuries into September.

The Bloomberg High Yield index fared well on an absolute and relative basis during July as riskier credits rallied alongside stocks with ‘peak inflation’ chatter making the rounds and recession fears receding amid hopes of a Fed pivot. After rallying throughout July, credit spreads on high yield bonds began August at/near levels last seen in early June prior to the FOMC’s meeting at which it announced the first of back-to-back 75-basis point hikes to the fed funds rate. As FOMC members come out in full force over the coming weeks to push back on the market’s expectations of a less aggressive pace of policy normalization, odds of a recession materializing at some point next year should rise and we would expect credit spreads on riskier corporate bonds to move wider. We maintain a neutral allocation to high yield corporates, but investors must pick their spots carefully as valuations again appear ‘fair’ to ‘rich’ given our outlook for economic growth and monetary policy.

Inflation expectations shifted modestly higher in late July as calls for a Fed pivot made the rounds, and as a result, FOMC speakers will continue to make a concerted effort to walk back the prospect of a pivot. Fed funds futures are pricing in better than even odds that the FOMC hikes the fed funds rate by 75-basis points at its September meeting as the July payrolls report gives the Committee cover to remain aggressive. We expect a volatile backdrop for rates to persist with inflation readings closely dissected and market-moving leading up to the September FOMC meeting and would remain nimble and stay diversified within fixed income portfolios as the monetary policy path forward remains highly uncertain.

Source: Bloomberg, Factset


The content and any portion of this newsletter is for personal use only and may not be reprinted, sold or redistributed without the written consent of Regions Bank. Regions, the Regions logo and other Regions marks are trademarks of Regions Bank. The names and marks of other companies or their services or products may be the trademarks of their owners and are used only to identify such companies or their services or products and not to indicate endorsement or sponsorship of Regions or its services or products. The information and material contained herein is provided solely for general information purposes. Regions does not make any warranty or representation relating to the accuracy, completeness, or timeliness of any information contained in the newsletter and shall not be liable for any damages of any kind relating to such information nor as to the legal, regulatory, financial or tax implications of the matters referred herein. This material is not intended to be investment advice nor is this information intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only current as of the stated date of their issue. Regions Wealth Management is a business group within Regions Bank that provides investment, administrative and trustee services to customers of Regions Bank.

Neither Regions Bank nor Regions Institutional Services (collectively, “Regions”) are registered municipal advisors nor provide advice to municipal entities or obligated persons with respect to municipal financial products or the issuance of municipal securities (including regarding the structure, timing, terms and similar matters concerning municipal financial products or municipal securities issuances) or engage in the solicitation of municipal entities or obligated persons for such services. With respect to this presentation and any other information, materials or communications provided by Regions, (a) Regions is not recommending an action to any municipal entity or obligated person, (b) Regions is not acting as an advisor to any municipal entity or obligated person and does not owe a fiduciary duty pursuant to Section 15B of the Securities Exchange Act of 1934 to any municipal entity or obligated person with respect to such presentation, information, materials or communications, (c) Regions is acting for its own interests, and (d) you should discuss this presentation and any such other information, materials or communications with any and all internal and external advisors and experts that you deem appropriate before acting on this presentation or any such other information, materials or communications.

Employees of Regions Asset Management may have positions in securities or their derivatives that may be mentioned in this report or in their personal accounts. Additionally, affiliated companies may hold positions in the mentioned companies in their portfolios or strategies. The companies mentioned specifically are sample companies, noted for illustrative purposes only. The mention of the companies should not be construed as a recommendation to buy, hold or sell positions in your investment portfolio.

This communication is provided for educational and general marketing purposes only and should not be construed as a recommendation or suggestion as to the advisability of acquiring, holding or disposing of a particular investment, nor should it be construed as a suggestion or indication that the particular investment or investment course of action described herein is appropriate for any specific retirement investor. In providing this communication, Regions is not undertaking to provide impartial investment advice or to give advice in a fiduciary capacity.