Bonds Commentary

Inflation Vs. Recession Tug-Of-War Ongoing

July 2022

Interest rates have been riding a volatility rollercoaster in 2022, a byproduct of monetary policy and economic uncertainty, and June was no exception. After eclipsing 3.5% mid-month, the 10-year U.S. Treasury yield moved lower in dramatic fashion to end the month below 3% as fears of a U.S. recession generated a bid for safe-haven Treasuries. Notably, the 10-year Treasury yield traded in a 70-basis point range between 2.85% on the low side and 3.55% on the high side during June, but the yield on the 10-year Treasury closed just 13 basis points higher at 2.98% as market participants pivoted from fearing inflation mid-month to pricing in a U.S. recession to close out the month. Global central banks are adjusting their messaging and the pace of policy normalization on the fly as the economic backdrop is evolving, and as market participants try to reposition to keep up with expected policy shifts large intra-day moves in rates are likely to remain a constant throughout the summer.

The Eurozone Consumer Price Index (CPI) for June rose 8.6% year-over-year after an 8.1% jump in May, taking the ‘peak inflation’ narrative off the table for Europe. The European Central Bank (ECB) has signaled its intention to raise key interest rates by 25 basis points at its July meeting, initially sparking selling in Euro Area sovereign bonds, but yields across the continent fell into month-end as recession fears dominated. As the ECB telegraphed plans to begin raising rates, it downgraded its forecast for growth in the Euro Area and revised its forecast for inflation upward. The revisions were not a surprise directionally, but the magnitude was as the ECB’s inflation projection for 2022 jumped from 5.1% in March to 6.8% in June, while its economic growth forecast was revised lower to 2.8% from 3.7% in March. Peripheral European countries are least capable of weathering slowing economic growth and rising inflation, but higher quality sovereign issuers are also likely to face headwinds as European Union (EU) countries are often viewed as guilty by association. Stronger EU member nations have traditionally been called upon to support or backstop the debt of weaker EU members to stabilize markets, and this possibility was discussed by the ECB in June as yields rose and credit spreads widened on peripheral sovereign bonds. This time around, Europe’s ‘core’ is already balking at stepping in as a backstop, which could prove disastrous for Euro Area bonds broadly.

FOMC members talked tough on inflation in June, despite market participants ratcheting the odds of a U.S. recession higher into month-end amid signs of a weakening economy. Yields on long-dated U.S. Treasuries were forced lower as a result. To take advantage of higher yields and to position for the possibility that the FOMC could tighten the U.S. economy into a recession, we modestly increased our portfolio duration in May to match that of the Bloomberg US Aggregate Bond index. Coinciding with our move to extend duration, we reduced exposure to mortgage-backed securities (MBS) and deployed capital into a core-plus strategy with a broader opportunity set. With yields on investment-grade and high yield corporate bonds higher at month-end, investors are better compensated for taking credit risk. However, slowing U.S. and global economic growth could spur additional spread widening and investors, us included, will likely require much higher yields before allocating additional capital to the space.

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.