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24 February 2023
Second chance saloon
Bond yields have come full circle as investors contend with the probability of a delayed recession. We think the sell-off in yields offers a second chance to get into bonds at historically attractive valuations..
Fundamentals
Two weeks ago, we wrote in the Bond Bulletin that markets had likely come too far, too fast in January. Bond yields have now come full circle as 10-year US Treasuries have sold off to their level from early January. Much of the move has been driven by investors re-assessing the timing of a recession and re-thinking the immediate path for US interest rates. The global economy has remained resilient in the face of higher rates, largely because many consumers and businesses refinanced when interest rates were low. As a result, inflation is not moderating as quickly as many central banks would like and investors now have to contend with the probability that a recession could be delayed, warranting further rate hikes and a higher terminal interest rate. The idea of higher rates for longer is now reflected in market pricing, with rate hikes of 25 basis points (bps) penciled in for each of the US Federal Reserve (the Fed) meetings in March, May and June. The probability of rate cuts in later 2023 has also been reduced. Markets are likely to remain in a holding pattern for the for foreseeable future while waiting for inflation data and subsequent steps from the Fed.
Quantitative valuations
The path of yields reflects the abrupt U-turn in the market narrative that has occurred this year. The US 10-year yield bottomed at 3.4% in early February but has now moved back to 3.9%, where it started the year. Interestingly, the sell-off in underlying government bond yields has not impacted investment grade (IG) spreads, which have remained well anchored in February. However, IG spreads typically do not peak until an economy is already in recession, suggesting spreads may be contained in the near term but could widen once the economy has entered a downturn. Overall, yields still look attractive for IG credit as the recent sell-off has pushed them back to 5.2% on the Bloomberg Global Aggregate Corporate Index. For investors who missed allocating to fixed income at the start of the year, this recent market move offers a second chance to get into the bond market at a historically attractive valuation.*
*All figures are as of 22 February 2023.
The US 10-year yield is now higher than at the beginning of the year
Source: Bloomberg, J.P. Morgan Asset Management. Data as of 22 February 2023.
Technicals
The possibility of a delayed recession has also triggered a change in flows in February. Emerging market debt saw significant inflows of USD 8.7 billion in January on the prospect of China re-opening and the reset higher in yields in 2022. However, investors have pulled USD 0.3 billion from the sector in February (as of 16 February 2023) as relative valuations deteriorated when core bond yields moved higher. In comparison, IG credit’s attractive valuations and robust corporate fundamentals have resulted in inflows of over USD 19 billion so far in 2023, the fastest start to a year on record, according to EPFR (as of 17 February 2023). In the event of a delayed recession, investors will likely continue to allocate to high-quality parts of the fixed income market that offer attractive yields.
What does this mean for investors?
The global economy has weathered the rate-hiking cycle surprisingly well. Such resiliency could delay the onset of a recession and force central banks to keep rates higher for longer. While the immediate economic and policy pathway remains unclear, long-term investors should not lose sight of the fact that current yields still offer an attractive entry point into fixed income, particularly in high-quality parts of the market, such as investment grade credit.
About the Bond Bulletin
Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.
Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.
Fundamental factors
include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings and leverage metrics)
Quantitative valuations
is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors)
Technical factors
are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum
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