Anfield Fixed Income Market Update: Mid-September 2022
During the first week of September, investors saw a data point unseen in over a generation—global bond markets are officially in a bear market. As of the time of this writing, the Bloomberg Global Aggregate Bond Index is down nearly 22% from its January 2021 peak (source: Bloomberg). Perhaps unsurprisingly, not all financial news publications responded in like manner. First, the Wall Street Journal with a matter-of-fact headline: “Global Bond Index Fell Into Bear Market.” Next, Bloomberg with another factual take, albeit with additional color: “Global Bonds Tumble Into Their First Bear Market in a Generation.” And finally, Reuters, with a headline that many surely sympathize with: “Analysis: Bond bear market: 'Worst year in history' for asset as inflation bites.”
A question many are understandably asking is, “Where do bonds go from here?” We want to highlight two important factors which we believe will impact bond prices going forward:
Inflation – We don’t believe investors will see inflation prints meaningfully higher than those we’ve seen in recent months (+8.3% YoY in August, +8.5% YoY in July; +9.1% YoY in June) given the Fed’s explicit commitment to fight inflation—a commitment which was reiterated by Fed Chair Powell at the recent Jackson Hole summit and then again during the September FOMC meeting. We believe this means that at least for a while, the Fed will continue to keep monetary policy tight, i.e. more rate hikes and ongoing balance sheet size reduction, resulting in moderating inflation prints, at least on a year-over-year basis. But it’s important to note that we see inflation moderating from these high levels, NOT falling drastically closer to the Fed’s 2% historic target. This should keep rates elevated at both the front-end and long-end of the yield curve, at least in terms of recent levels.
Economic Contraction – We don’t believe the current economic slowdown will result in a bond bull market where investors flock to perceived safe-haven assets like Treasuries and other high quality fixed income instruments. Regardless of one’s definition of a “recession”, we’ve had two consecutive quarters of negative GDP growth (Q1: -1.6%, final estimate; Q2: -0.6%, second estimate); the economy is clearly slowing. During this contractionary period, the 10 Year Treasury yield has risen from 1.52% at year-end 2021 to 3.57% as of September 20, 2022. This is hardly the “flight to quality” we’ve seen in past recessions (e.g. Great Financial Crisis, COVID Pandemic) and given both Fed actions and inflation (see above), we don’t expect to see a flight to quality trade assuming the market is correctly pricing in a mild to moderate recession. In our view, even if we are in an official recession, this doesn’t automatically mean that aggregate bonds will or should rally.
So where do bonds go from here? We are still of the view that there is more pain coming in aggregate bond indices. To be sure, plenty of pain (and possibly most of the pain) has been felt already in YTD bond returns (more below). However, the macro environment as described above does not paint a happy outlook for bonds, even when factoring in YTD losses. The Fed will very likely keep pressure on the front-end of the curve and the market will likely keep pressure on the long-end given decades’ high inflation. Our message to clients is this—keep duration low and pick your risks carefully.
Current Fixed Income Positioning
Universal Fixed Income Strategies: Benchmark agnostic and line-item bond security portfolios looking to highlight our best ideas in bond space
Dynamic Bond strategy: Benchmark aware to the Bloomberg Barclay’s Aggregate Index and is a top-down macro-focused ETF of ETFs.
“Anfield Affection Gauges”: What fixed income sectors & exposures do we like, and what do we dislike?
Current Fixed Income Positioning Definitions:
Duration represents the current value for each of the funds and indices noted
Curve represents where each of the funds and indices are positioned on the yield curve
Government represents the percentage allocated to Government bonds within the funds and indices
Credit represents the percentage allocated to Investment Grade and High Yield Credit within the funds and indices
MBS represents the percentage allocated to Mortgage-Backed Securities within the funds and indices
Yield (YTM) represents the Yield to Maturity of the funds and indices
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