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- Global fixed income returns were mixed in October. In the US, investment grade corporates generated a positive coupon-like return, while high yield and Treasuries declined
- US investment grade corporate outperformance this month was primarily a function of a rally in 30-year bonds (30-year rates declined). As market expectations rose around a potential increase in the Federal Reserve (Fed) Funds rate, the yield curve flattened with the short-end rising and long-end declining
- In Europe, inflationary pressures and supply chain disruptions weighed on the growth outlook
- Emerging Markets (EM) contended with the rise in short-end US rates as well as continued volatility in China; mostly related to the property sector and ongoing drought-led power shortages
US fixed income returns were mixed in October with investment grade corporates generating a positive coupon-like return and high yield and Treasuries declining. Investment grade corporate outperformance this month was primarily a function of a rally in 30-year bonds (30-year rates declined). As market expectations rose around a potential increase in the Federal Reserve (Fed) Funds rate, the yield curve flattened with the short-end rising and long-end declining. This is to be expected when the Fed enters a hiking cycle. October was the first negative return month for the broad US high yield market since September 2020 as the market digested issues ranging from early reported earnings, to inflation concerns, to Treasury volatility. CCC underperformance stood out during October after being resilient during a lackluster September as investors appear to have repriced some CCCs. Supply was manageable during the month with many issuers entering quiet periods before earnings. There were no high yield defaults during October, the fourth consecutive month, and the default rate is now 0.44% (Source: J.P. Morgan Default Monitor, November 1, 2021). The default rate is at its lowest level since 2007, something we predicted would happen in September. The declining default rate and the low level of distressed bonds is setting up a below average default rate through 2023; this is a bullish sign for an extended period of stable credit spreads.
This month uncertainty around the European economic recovery continued as inflationary pressures and supply chain disruptions weighed on the growth outlook. In another month dominated by rates uncertainty, returns from both European investment grade and high yield remained in negative territory while spreads widened. High yield, with its greater spread cushion able to absorb more of the rate moves, outperformed investment grade. Within investment grade, the yield curve started to flatten – short rates moved up faster than the longer end as the market appeared to price in more “permanent” inflation, led by soaring gas prices as increasing demand met with supply concerns. Nevertheless, despite increased pressure on the European Central Bank (ECB) to tighten monetary policy, President Lagarde continued to leave forward guidance unchanged. Instead, the pandemic emergency purchase program (PEPP) will continue to run at a moderately lower pace with any further major decisions postponed to the December meeting. The ECB continues to believe eurozone inflation will decline next year and is consequently forestalling policy changes, despite the broader market view that supply chain bottlenecks and inflationary pressures will likely continue well into 2022.
Emerging Markets (EM) fixed income returns declined this month driven by a rise in short-end US Treasury rates and continued volatility in China; mostly related to the property sector and ongoing drought-led power shortages. By the close of the month, however, positive headlines from China began to dominate and Chinese securities rebounded considerably. Further, the month ended optimistically with oil and natural gas inventories reported at higher levels than at the beginning of the month and market expectations indicating full oil demand recovery in 2022. We continued to see strong reported earnings, robust technicals, company buybacks, and strong retail flows, even as inflation continues to be the market’s main concern globally. While Turkey has continued to pursue its unorthodox methods to tame inflation (by cutting interest rates), other EM central banks—notably Brazil—aggressively hiked interest rates this month.