Displaying items by tag: fixed income

In a piece for the ETF Database, Todd Rosenbluth examines whether the strong performance of fixed income ETFs will continue in the second-half of the year. In total, the asset class had $200 billion of inflows which represented 49% of all inflows despite fixed income ETFs only accounting for 19% of total assets. 

Given the uncertainty around the economy and monetary policy, it shows that investors are looking to take advantage of higher yields as well as a structural shift towards the asset class. Both stocks and bonds have posted positive returns following a down year in 2022. 

This is despite a headwind from the Fed’s rate hikes which look likely to continue into year-end following a recent spate of positive economic data. Due to this, yields on Treasuries have exceeded their March highs. So far, the strength in the bond market has been contained to the long-end especially following the recent inverting of the curve following a string of better than expected employment data. 

Within the asset class, active fixed income ETFs saw $8 billion of inflows. Active fixed income ETFs have a better track record of outperforming their benchmark due to the ability to buy durations and assets that are unavailable to passive fixed income funds. While only 26% of active equity funds outperformed the S&P 500, 48% of active fixed income funds outperformed their benchmark in 2022.

Finsum: Fixed income ETFs saw a surge of inflows in the first-half of the year due to attractive yields. However, there remains considerable uncertainty in the second-half of the year given the economy and Fed.

In Bloomberg, Garfield Reynolds covers the weakness in bond markets following a flurry of better than expected economic news which is making clear that a recession is not imminent. Between March and June, bonds were in the midst of a spectacular rally due to inflation slowing, increasing signs that a recession was likely in the second-half of the year, and financial stress caused by the failure of regional banks.

Yet, these gains have been quickly wiped away in the past month amid strength in the labor market and consumption. Also, it’s now apparent that the Fed’s hiking cycle is not over. Consequently, a global index of government bond yields have hit their highest level since September 2008 which precipitated the Great Recession. Adding to bond woes is the consensus expectation that Treasury yields had peaked. 

It’s also impressive that despite weakness in regional banks, there has been no contagion effect in terms of tighter credit which could potentially add to recessionary impulses. However, some market participants are wary that further weakness in bonds could result in strains to the banking system and result in a ‘deposit flight’ to Treasuries. 

Finsum: Fixed income has been in a brutal bear market over the past month as the market’s consensus about a bond bull market, slowing economy, and the Fed being finished in terms of rate hikes have proven to be false. 

Yields on Treasuries shot higher following the June ADP private sector jobs report which came in much stronger than expected at 497,000 vs 228,000. This is a continuation of a trend in recent months, showing that economic growth and the labor market are defying consensus predictions of a recession.

In fact, many analysts now believe that the economy could be re-accelerating which has major implications for fixed income and equities. Immediately following the report, odds increased for rate hikes at the next 2 FOMC meetings, and odds for a cut in the first quarter of 2024 sharply declined.

Higher yields and tighter monetary policy are certainly headwinds for equities and fixed income. Additionally, one of the catalysts for the recent rally in equities has been expectations of an imminent Fed pivot given weakening inflation and a softening labor market. Yet, data over the last month have made it clear that the Fed still has more work to do to achieve its objectives.

It’s also interesting to note that yields on shorter-term Treasuries are now approaching their highs from early March. Further, the decline from March into May following the collapse of Silicon Valley Bank and distress at other regional banks has been entirely reversed. 

Finsum: Fixed income weakened following the ADP jobs report which showed that private sector hiring was twice as strong as expected. Ultimately, the report likely means that rates will go higher and stay elevated for longer than expected.

In a piece for Bloomberg, Michael McKenzie and Ye Xie discuss recent economic data which has dispelled the notion that the economy is on the verge of a recession. This has resulted in traders pushing back their timeline of when the Fed will start its rate-cutting cycle and increases the odds that the Fed will continue hiking rates.

Both developments are bearish for fixed income. YTD, the asset class has enjoyed strong gains but this was, in part, due to expectations that inflation and economic growth will continue trending lower, leading to a pivot in Fed policy.

In addition to these catalysts, inflows into fixed income have been strong as traders look to lock in higher yields. Yet, these yields are here to stay at least for some time given the stickiness of inflation and the resilience of the labor market and consumer spending. 

Clearly, the market has been caught off guard as well. This is evident from the huge jumps in yields on short-term Treasuries following better than expected jobs reports in recent months. Additionally after a short blip higher, jobless claims are once again trending lower, indicating that while turnover has increased, the economy continues to add jobs. 

Finsum: Fixed income has performed well YTD, but the asset class’ gains are eroding as the odds of a recession and imminent Fed rate cut cycle have diminished. 

In an opinion piece for Bloomberg, former NY Fed Chair Bill Dudley shared his thoughts on why there is likely to be more weakness in Treasuries despite increasing indications that inflation is bending lower. 

While longer-term yields have declined as a result, they are starting to creep higher as the economy continues to show momentum with some signs of an acceleration. Hopes that the Fed’s hiking cycle was over seem premature as Fed funds future markets now show hikes at the next two meetings.

Even if the Fed is close to the end, a robust economy means that rates will likely stay elevated at these levels for a prolonged period of time. Further, Dudley sees structurally large deficits, baby boomers spending down retirement accounts, and capital expenditures in renewables and reshoring supply chains as reasons that inflation is likely to linger above the Fed’s 2% target. 

Higher inflation will also erode returns on longer-term Treasuries, leading to higher yields. This has the potential to cause stress to the financial system as we saw with the regional banking crisis especially as Treasuries make up the capital base of so many institutions. However, Dudley sees one silver lining as it could force politicians to address the country’s weakening fiscal situation.

Finsum: Former NY Fed Chair Bill Dudley doesn’t share the market’s optimism that the worst of the inflation surge is over. He sees structurally higher inflation as a headwind for Treasuries.