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May 2023

Bonds Record Another Strong Quarter







Key Points

  • Despite potential headwinds from deposit withdrawals at many regional banks, Investment Grade bonds achieved positive performance in March
  • The MOVE index, a well-recognized benchmark for US Treasury market volatility, surged over the quarter
  • We are cautious on leveraged loans given the nature of their use for private equity transactions and floating rate characteristics

Taxable fixed income markets recorded a second straight quarter of positive performance, driven by a fall in Treasury rates, after the 10-year US Treasury bond set a high of 4.33%1 on October 21, 2022. Additional Federal Reserve rate increases and higher long-term interest rates drove the reversal in performance, as well as a healthy credit environment in which default rates remained historically low.

Over the quarter, the broad US Investment Grade market returned 2.96%, and US corporate bonds returned 3.50%2. Despite potential headwinds from deposit withdrawals at many regional banks, Investment Grade bonds also achieved positive performance in March, as the broad index climbed 2.54%3. Notably, financial sector performance was also positive throughout the turmoil, rising 1.42%4.

While the moves were positive, the market continued to experience high levels of volatility. The MOVE index, a well-recognized benchmark for US Treasury market volatility, surged over the quarter, exceeding its 2020 COVID high while falling just short of the maximum point reached in 20085. While high, volatility measures the absolute movement in rates, not the direction. As a result of the decline in yields to start the year and the flight to quality during March6, the bond market has largely benefitted from rate volatility — a stark contrast from 2022.

 

High yield markets have also achieved positive performance in 2023. US high yield bonds, leveraged loans and emerging market high yield bonds were up 3.57%, 3.25% and 1.58%, respectively7. We continue to expect yields above 8%8 to drive positive total returns. We also believe default rates will approach long-term averages but not move meaningfully above levels typical of a normal credit cycle. 

Ultimately, this should be around 5-6%9. However, we are cautious on leveraged loans given the nature of their use for private equity transactions and floating rate characteristics. High yield bonds have a major advantage over loans, given average fixed coupons of just 5.9% with an average maturity of 5.3 years10. This is in stark contrast to loans with average yields of 9.4%11, which is likely to put cash flow pressure on leveraged businesses.

Looking forward, the strong performance over Q1 2023, supportive credit environment and stable economic fundamentals point toward positive total returns, especially after the adjustment in yields last year.

 

 

1US 10-Year Treasury Yield, Bloomberg: GT10 Govt

2 Broad US Investment Grade Market: Bloomberg US Aggregate Bond Index, Bloomberg: LBUSTRUU Index; US Corporate Bonds: Bloomberg US Corporate Bond Index, Bloomberg: LUACTRUU Index

3 Investment Grade Bonds: Bloomberg US Aggregate Bond Index, Bloomberg: LBUSTRUU Index

4 Financial Sector: Bloomberg US Financial Institutions Capped Index, Bloomberg: I27906 Index

5 Ice BofA MOVE Index, Bloomberg: MOVE Index

6 US 10-Year Treasury Yields dropped peak-to-trough by 73 bps in March, Bloomberg: GT10 Govt

7 US High Yield Bonds: Bloomberg US High Yield Index, Bloomberg: LF98TRUU Index

Leveraged Loans: Morningstar LSTA Leveraged Loan Index, Bloomberg: SPBDAL Index

Emerging Market High Yield Bonds: Ice BofA High Yield USD Emerging Markets Liquid Corporate Plus Index, Bloomberg: EMHY Index

8 US High Yield Corporate bonds have an average yield above 8% as of 3/31, Bloomberg: LF98YW Index

9 Moody’s Bond Only Moderate Pessimistic Forecast for Default Rates, Moody’s February 2023 default report 

10 Bloomberg, LF98TRUU Index (Field: CPN and Field: WEIGHTED_AVERAGE_MATURITY_YEARS)

11 Morningstar LSTA Leveraged Loan 100 Weighted Average Yield, SPBDLLY Index as of March 31, 2023.

Past performance or performance based upon assumptions is no guarantee of future results.

Index performance is provided as a benchmark. It is not illustrative of any particular investment. Indices are unman-aged, and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.

Indexes are unmanaged and do not reflect a deduction for fees or expenses. Investors cannot invest directly in an index.

 




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