The fixed income market struggled in the third quarter of 2023 as the US Fed signaled a “higher for longer” rates scenario. The Bloomberg Aggregate Bond Index dropped more than 3%, with the US bond markets recording their worst quarter of the year. The Fed has hiked rates by 100bps since the beginning of this year to 5.25-5.50% (highest level in more than 20 years), and investors will recall that it was just hovering around zero in the first quarter of 2022.

Among the fixed income market segments, government bond returns were negative across the developed markets as yields rose sharply. The US Treasury market was a notable laggard, especially on the longer duration front, which plunged almost 12% as the yield curve steepened. High quality investment grade credits remain generally stable, while US and European high yield corporate bond markets managed to eke out positive returns, returning 0.5% and 1.5% respectively, due to their lower sensitivity to the recent rate movements.

To date, high yield bonds remain the top performing sector, with the US and European benchmarks returning about 6%. In a rising yield environment, the short-dated profile of high yield bonds provides a source of resilience, with bond spreads broadly flat over the quarter.

Looking ahead, the market has shifted focus from where the level of peak US Fed fund rates will be, to how long global central banks hold rates at restrictive levels, with “higher for longer” increasingly being viewed as the base-case scenario, in order totame stubborn inflationary and price pressures. Meanwhile, US fiscal sustainability has also become an area of concern for investors, with the treasury market being hit the hardest by worries over the amount of issuance required to sustain a large fiscal deficit in the US over time.

While we believe that price pressures across the globe (ex-China) may gradually ease in tandem with an expected slowing global economy, the US inflation data remains fluid. The sell-off in long-dated US treasuries have yet to run its course, and we are currently in an environment of high borrowing costs. Hence, investors will be prudent to maintain a short duration profile of high-quality corporate credits.

Geopolitical risks are increasing, particularly with rising tensions in the middle east. We hope the wisdom of the global political leaders will prevail, and peace will return.

I wish you safe & happy investments!

30 Sep 2023