Opportunities abound in fixed income so far in 2023

2022 was the worst year on record for bonds in the wake of the Fed’s aggressive rate hikes to cool the economy and tame inflation. Yet 2023 could be better for bond investors as the paradigm is changing. 

The futures market for the Fed funds rate is predicting a peak of about 5%, to be reached in May. As the Federal Reserve had raised the Fed funds rate by 50bps to 4.25%-4.5% during its last monetary policy meeting in December, it means that the tightening cycle is nearing an end. Most of the losses in fixed income are likely behind us. Bonds may offer significant capital gains once this final adjustment is complete and the central banks start to slow or even stop shrinking their balance sheets. For the record, the Federal Reserve has already allowed its balance sheet to shrink by nearly $460 billion from the peak observed in mid-April 2022, to $8.5 trillion as of the latest data today.

From this perspective, investors have certainly found hope in December’s jobs report. Nonfarm payrolls rose 223,000 last month. Even if it beat the consensus forecast for 200,000, it’s below the downwardly revised 256,000 jobs added in November. We should bear in mind that December’s jobs total represents the lowest monthly gain in two years. That’s a key point as we know that the Fed is focused on the labor market tightness as the key driver of inflation. The second good news is that the wage growth was less than expected. This data shows that inflation pressures could be weakening. Needless to say that bond markets welcomed the news.

The yield on the benchmark 10-Year U.S. Treasury Note fell 32 basis points from 3.88% to 3.56%. The spread between the 2-year and 10-year yields is now at -70 basis points. In Europe, the yield on the German 10-year Bund was down 36 basis points to 2.21%.

The riskiest bond segments rallied in unison. 

Investment grade corporate bond prices were up +1.62% in Europe (IBOXX € Liquid Corporates index) and up +1.56% in the U.S. (IBOXX Ishares $ Investment Grade Corporate Bond Index).

High-yield bonds gained +1.03% in Europe (IBOXX € Liquid High Yield Index) and +2.25% in the U.S. (Markit iBoxx USD Liquid High Yield Capped Index).

Lastly, emerging debt in local currencies chalked up a 1.31% gain.

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.