2024 Midyear Outlook: Can Investors Find Solid Ground in Fixed Income?

When we began 2024, six interest rate cuts were expected. But with stickier-than-expected inflation and strong job growth, markets significantly lowered those expectations. As a result, rising interest rates created headwinds for rate-sensitive assets, although a resilient economy helped lower-credit-quality parts of the fixed income market (e.g., high-yield and bank loans) outperform their higher-credit-quality counterparts.

So, can investors find solid ground in the fixed income market as we head into the second half of the year? With the movement in interest rates and dispersion in asset class performance, we believe there are opportunities within the landscape. 

Exploring Higher-Yield Terrain

On the surface, yields across fixed income sectors are elevated compared to the last decade (see chart below). Higher-quality sectors (e.g., Treasuries and investment-grade corporates) offer some of the highest yields in years, while lower-credit-quality sectors are not quite at the top of their historical range.

Fixed Income Yields Elevated Across Sectors

All indices are Bloomberg, except for emerging market debt and leveraged loans: EMD (USD): J.P. Morgan EMIGLOBAL Diversified Index; EMD (LCL): J.P. Morgan GBI-EM Global Diversified Index; EM Corp.: J.P. Morgan CEMBI Broad Diversified; Leveraged Loans: JPM Leveraged Loan Index; Euro IG: Bloomberg Euro Aggregate Corporate Index; Euro HY: Bloomberg Pan-European High Yield Index.
Source: J.P. Morgan Guide to the Markets, as of May 31, 2024

Here, it’s important to keep in mind that yields for non-U.S. Treasury investments are composed of the risk-free Treasury rate plus a spread for the additional risk investors take on. This spread can be a key driver of returns.

Tightening spreads (i.e., less compensation for the additional credit risk) have contributed to the outperformance of below-investment-grade securities. For example, high-yield bonds have performed well so far this year, but the spread of the ICE BofA US High Yield index has reached the historically tight levels we saw in 2021 (see chart below).

High-Yield Spreads Revert to Tight Levels

Source: Federal Reserve Bank of St. Louis, as of June 3, 2024

If economic conditions worsen, spreads could widen across fixed income sectors, leading to negative performance for investors. Widening spreads often lead to lower bond prices, which move inversely to yield.

Finding Pockets of Opportunity

While the terrain is uneven and there’s dispersion and movement in fixed income markets, savvy investors may find pockets of opportunity:

• U.S. Treasuries: U.S. Treasury yields have risen to the highest levels seen over the past decade. If the Fed can bring in inflation during the coming years, Treasuries at current yield levels may be an attractive long-term option.
• Corporate Bonds: Though spreads are still relatively tight, there are areas of value. The Bloomberg U.S. Corporate Bond Index (which tracks investment-grade securities) is yielding about 5.5 percent, as of the end of May, and the fundamentals remain fairly strong. Plus, high-quality corporate bonds have historically weathered challenging economic conditions well due to their strong balance sheets.
• High-Yield Bonds: Despite a strong start to 2024, caution is warranted for high-yield bonds given their economic sensitivity, rising default rates, and below-average recovery rates. Additionally, while yields are high on an absolute basis, they are below their long-term average on a relative basis.
• Municipal Bonds: Municipal bond yields continue to remain strong. The Bloomberg Municipal Bond Index ended May with a yield-to-worst of 3.77 percent, a taxable-equivalent yield of approximately 5.98 percent for a U.S. investor in the top federal tax bracket. Further, fundamentals are strong for higher-quality municipals due to years of economic expansion and fiscal support.

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