Taxable Strategies: Interest Rates Aren’t Done Moving Higher
- The 10-Year U.S. Treasury Yield set a new high of 4.8%.
- Floating rate high yield has benefited from a stronger economy and is out-performing.
- Portfolios should be positioned conservatively in strong companies.
The third quarter was characterized by a resumption in the higher-for-longer trend. The U.S. 10-Year Treasury Note moved higher by 1.05%, ending the quarter at 4.8% and putting last October’s interest rate peak of 4.2% in the rear-view mirror1.
While high starting yields helped offset disruptive price moves, it wasn’t enough to keep returns positive and high-quality bond markets gave back most of the 2023 gains. The Bloomberg U.S. Government/Credit Intermediate Index fell -0.8% over the quarter, pushing YTD returns from as high as 3.5% in early May to just 0.7% by September2. While the bond market is experiencing a surge in interest given the rise in yields, investors should remain cautious on the overall level of rates and the economic factors, such as inflation, tight labor markets and geopolitical events, that continue to put pressure on yields.
Chart 1: HY FV Spread: January 1997 – August 2023
Source: Bloomberg, CNR Research, as of September 30, 2023.
Indexes are unmanaged and do not reflect a deduction for fees or expenses. Investors cannot invest directly in an index.
While interest rates have been volatile, high yield credit markets continued to perform as high starting yields overwhelmed price movement. Over the quarter, spreads, which measure risk levels in credit, ended where they started at 3.9%3 over comparable U.S. Treasuries and the broad market finished up 0.5%4. Performance began to significantly diverge between floating rate securities and fixed rate securities. High Yield Bank Loans rose 3.43% and are now up 10.2% for the full year, 4.3% above U.S. High Yield Corporate Bonds5. Lower than expected default rates and the increased probability of an economic slowdown as opposed to a recession have fueled high yield returns.
Despite the positive performance of higher yielding debt and the attractiveness of yield levels, we believe now is the time to ensure portfolios are invested in stronger credits that generate free cash flow and can cover rising interest rate costs. Our credit models show that high yield markets could move up by 3% or more6 and we expect volatility as we move into 2024.
Chart 2: U.S. High Yield Fixed Rate vs. Floating Rate Markets
Source: Bloomberg, as of September 30, 2023
U.S. High Yield Bonds: Bloomberg: LF98YW Index: The Bloomberg US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Bloomberg EM country definition, are excluded. “YW” is the ticker to pull the yield-to-worst on the index.
U.S. High Yield Loans: Bloomberg: LF98TRUU Index: The Bloomberg US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Bloomberg EM country definition, are excluded. This is the total return index level.
1 U.S. 10-Year Treasury, Source: Bloomberg, Ticker: GT10 Govt., Closing Levels
2 Bloomberg Government/Credit Intermediate Index, Source: Bloomberg, Ticker: LF97TRUU
3 Bloomberg High Yield Corporate Bond Index, Source: Bloomberg, Ticker: LF98TRUU
4 Bloomberg High Yield Corporate Bond Spread Index, Source: Bloomberg, Ticker: LF98OAS
5 Leveraged Loans: Morningstar LSTA Leveraged Loan Index, Source: Bloomberg, Ticker: SPBDAL
6 Proprietary Fair Value Spread Model, Source: CNR
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 unmanaged, 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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