Bonds: Safety Bid Under Treasuries Could Persist
August 2024
Treasury yields across the curve have moved sharply lower since the start of July as geopolitical and economic growth fears have dominated. The U.S. Treasury yield curve steepened throughout much of July as the likelihood the FOMC would cut rates in September increased, attempting to end one of the longest yield curve inversions in history. The yield on 10-year U.S. Treasury notes was only 22-basis points above the yield on 2-year notes at month-end, and that spread has narrowed further early in August and hovered closer to 10-basis points at the time of this writing. The shrinking spread between those two often-quoted maturities is the narrowest it has been since July of 2022, the same month the current curve inversion began.
Historically, the yield curve normalizing has been viewed as an ominous sign for markets and central bankers as it has signaled that monetary policy needs to become more accommodative to stimulate economic growth and avoid recession, but the recent track record for this indicator has been spotty and a poor market timing tool. There is little in the economic data at present to indicate a U.S. recession is in the offing, but we are entering a notoriously tough stretch in the calendar for stocks and riskier assets from August through October and interest rate volatility is likely to remain elevated as a result.
The move lower in Treasury yields is understandable given rising geopolitical tensions, but absent a panicked FOMC aggressively cutting rates in the coming months and/or a U.S. recession materializing, which we don’t anticipate, the magnitude of the move lower isn’t likely to be sustained. However, with economic, political, and geopolitical uncertainty heightened in the coming months, upside for Treasury yields could be limited in the near-term with 4% a potential area of resistance for both 2- and 10-year Treasury yields. With yields falling sharply across the Treasury curve in July, most tenors now appear ‘rich,’ and while we slightly favor shorter-term Treasuries given our view that recession concerns are overblown, we aren’t convicted enough in that view to deviate from our preferred strategic positioning which is a duration profile in-line with that of the Bloomberg Aggregate Bond index.
Corporate Credit A Relatively Good Place To Be, But We Don’t Want To Overstay Our Welcome. Corporate borrowers were active in the lead-up to the FOMC’s meeting on July 30-31, bringing $32B in corporate bonds to market in the two days preceding the Committee’s decision on rates mid-week. The flurry of corporate issuance, along with fears of a U.S. economic slowdown building forced credit spreads on corporate bonds wider during the first week of August to levels last seen in November of 2023. At the time of this writing, the Bloomberg U.S. Corporate and U.S. Corporate High Yield indices carried a yield-to-worst of 5% and 7.80%, respectively, which is far from a screaming buy by historical standards when viewed in isolation but remains attractive relative to other segments of the fixed income market, specifically, Treasuries.
Rising geopolitical tensions and economic growth concerns put downward pressure on Treasury yields as the calendar turned from July to August, which we believe are overblown, investors are likely to find relative value in ‘spread sectors’ of the fixed income market. Investment-grade corporate bonds should benefit even if Treasury yields fall further due to their longer duration profile, while also faring well versus Treasuries if growth concerns fade. High yield corporate bonds are more susceptible should the economic outlook deteriorate as issuers are more negatively impacted from a lack of available credit, but with credit spreads now just back to levels seen in early January, we aren’t yet seeing signs that the panic selling in stocks has spread to riskier corporate bonds, leading us to view this pullback as healthy.
Fears of economic slowdown or recession building in early August pushed credit spreads wider, a common occurrence when investors become more concerned about the economic growth outlook and the potential for corporate bankruptcies to rise in a material way. However, indiscriminate selloffs or steep pullbacks in corporate bond indices can provide opportunities for active managers to add value as they can pick up the babies thrown out with the bathwater, and while we don’t want to overstay our welcome in high yield, we view the recent pullback as more of an opportunity than a cause for concern.
As of August 7, 2024
