Right Back Where We Started
The bond market for the quarter can be described like the journey of a billionaire astronaut, going up then down, and ending in the same place. The 10-year U.S. Treasury yield ended the quarter just 0.02% higher than last quarter. Across all maturities, yields barely changed, but what a memorable ride it was. By early August, bonds advanced 1.37% as the economic outlook turned dismal as shut-down news and slow back-to-school sales created a buzz that the Federal Reserve would delay the start of or slow its tapering plans. Both bonds and stocks rose on a thesis that a further extension of Federal Reserve economic stimulus would boost asset prices.

By late August, the Federal Reserve Governors used their Jackson Hole meeting to return to the script they laid out earlier in the year. Talking points emphasized that strong economic growth is well underway and while inflation is proving less transitory than initially expected, monetary policy should become less accommodative. This policy direction was clarified at the Sept. 22 policy meeting as greater information was revealed, but not finalized, on when the Fed’s open market operations group would slow its bond buying program and start to cull its $8.4 trillion balance sheet. At this same meeting, a first look at the Fed’s 2024 outlook was seen by bond investors as more hawkish, leading to a steepening of the yield curve as quarter-end approached.

High Grade bonds made a similar round trip during the quarter, as risk premiums reflected by spread initially widened on concerns of how a slowing economy would impact corporate earnings but then declined as rising yields boosted the outlook for better bank revenues. Corporate bonds are heavily weighted to banks at 22% of the market and a rise of interest rates benefits this sector. After posting returns of -0.002% this quarter, our outlook for corporate bonds remains cautious as further spread tightening is unlikely. Historically, spreads have only been this low 10% of the time since 2000.

A rising supply of newly minted municipal bonds has meant this sector broke trend, rising 11 basis points across longer maturities. With prices dropping, the sector turned in a -0.27% return for the quarter but still outpaced other sectors year-to-date at +0.79%. Early in the year, prices were boosted by heavy buying in anticipation of tax policy changes. Our outlook remains positive on the sector’s credit conditions, but still negative on a relative value basis.

Our outlook over the near term is for bond prices to continue to move sideways in a range similar to what we have seen over the last quarter and not repeat declines like those during the first quarter. This would give corporate bonds a slight edge, but any disappointment of earnings can quickly erase this relative advantage.

Source: BTC Capital Management, Bloomberg LP, Ibbotson Associates, FactSet, Refinitiv.
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