Terminal Rate Debate Dominates
Interest rate markets repeated their dreary performance in October: interest rates rose and absolute returns in most segments of the bond market were negative. As has been the case all year, shorter-term holdings were the best relative performers. High yield corporate bonds and similar lower-rated bonds outperformed high quality.
The market continues to try to divine the Federal Reserve’s (Fed) notion of what the “terminal rate” (the peak of the Fed Funds rate) will be. For its part, the Fed continues to state they will follow the data and that they are not wedded to any specific level or timetable.
Corporate earnings season is again in full swing, and earnings results for the third quarter have been generally better than feared. This influenced the strong monthly performance by risk assets such as equity markets and high yield bonds.
Even after the Fed is done hiking rates, it may be a while before we see any meaningful drop in the Fed Funds rate, as they will likely want to be sure inflation is truly controlled. Nonetheless, tightening cycles do not last forever, and rising yields today set the table for positive real returns and good investment opportunities tomorrow. Read on for deeper analysis of all corners of the fixed income markets in October.
Market Summary
High yield corporates were the top performer in October, posting solid gains – a rarity in 2022. Other major categories added to their year-to-date losses.
U.S. Treasury Market
Treasury yields rose across the curve in October, hitting calendar-year highs. The 2s to 10s curve stayed inverted for a fourth consecutive month.
T-Bills continue to benefit from the rise in rates; other Treasuries posted losses for October. TIPS returns were positive in October but have generated losses year-to-date.
Broad Investment Grade
All components of the Bloomberg Aggregate Bond Index (the Agg) posted negative absolute returns in October. Corporate bonds were the strongest performers relative to Treasuries, which drove the Agg to a narrow outperformance versus similar duration Treasuries.
Intermediate corporate bond spreads widened in the month while long corporate spreads and mortgage-backed securities (MBS) spreads tightened.
BBBs were the top absolute performers among investment grade rating categories, while AAAs were the best performer relative to similar duration Treasuries. All ratings categories generated negative absolute returns while outperforming Treasuries.
Spreads on Financial sector bonds widened in October, while every other investment grade sector tightened. Energy sector bonds tightened the most in the month.
High Yield
High yield (HY) bonds enjoyed a strong month both in absolute terms and relative to Treasuries as spreads moved tighter across all HY ratings categories. Single Bs were the top-performing ratings category.
Spreads tightened for all HY sectors, led by Consumer Cyclicals.
The high yield default rate remains low from a historical perspective, increasing just slightly in October.
Municipals & Other
Yields on municipal bonds rose across all maturities and ratings categories. Returns were negative across all duration categories for October.
Returns were mixed in the various “other” markets. Leveraged loans continue their strong relative performance year-to-date; the remaining categories have posted large losses in 2022.
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This update provides an overview of certain broad-based Fixed Income benchmarks and does not include performance of the Segall Bryant & Hamill Fixed Income styles. Past performance cannot guarantee future results. All investments involve risk, including the possible loss of capital. All opinions expressed in this material are solely the opinions of Segall Bryant & Hamill. You should not treat any opinion expressed as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of the manager’s opinions. The opinions expressed are based upon information the manager considers reliable, but completeness or accuracy is not warranted, and it should not be relied upon as such. Market conditions are subject to change at any time, and no forecast can be guaranteed. Any and all information perceived from this material does not constitute financial, legal, tax or other professional advice and is not intended as a substitute for consultation with a qualified professional. The manager’s statements and opinions are subject to change without notice, and Segall Bryant & Hamill is not under any obligation to update or correct any information provided in this material.
1 Source: Bloomberg.
2 Source: Bank of America Merrill Lynch.
3 Hypothetical yields are calculated as the AA municipal yield divided by (1-tax rate). Actual tax-adjusted yields will depend on individual tax circumstances.
4 Source: Standard & Poor’s.