Bond market turns negative for the year amid rising interest rates
Third quarter returns were negative across most fixed income categories. The Bloomberg U.S. Aggregate Bond Index (the Agg) lost over 2.5% in September alone, leading to a quarterly loss of more than 3.2% and dropping the Agg into loss territory year-to-date. Prior to 2021, the Agg had not lost more than 3% in a single quarter since 1981; it has now happened in five of the past 11 quarters.
Interest rates rose across the curve, most notably on the long end. In the process, Treasury yields reached their highest levels since 2007 across virtually the entire curve. The Federal Reserve (Fed) raised its benchmark Fed Funds rate by 0.25% in July before pausing in September as it contended with economic data showing rising inflation and persistently low unemployment. The Fed’s statements have affirmed that they will remain “data dependent” on determining next moves.
Corporate bond spreads were mixed in the quarter. Short and intermediate investment grade (IG) corporate spreads widened slightly, while spreads on long corporates tightened. Spreads on mortgage-backed securities (MBS) also moved wider across most coupons. High yield (HY) corporates were a relative outperformer in the quarter, driven by strong performance from the riskiest HY rating category, CCCs. The HY default rate moved slightly higher in the quarter but remains low by historical standards.
Read on for more analysis of the fixed income market for the third quarter.
Market Summary
Third quarter returns were negative for most fixed income categories; only high yield corporates produced a positive return.
U.S. Treasury Market
Treasury yields rose sharply in the quarter, most notably on the long end of the curve–a “bear steepener” move. Yields hit their highest levels since 2007 across most of the curve.
The shortest Treasury securities produced positive returns, benefiting from higher yields and current coupon payments. Longer-duration Treasuries were the worst performers due to their higher sensitivity to changes in rates.
Broad Investment Grade
The Agg lost over 3% in the third quarter, led lower by long corporates, MBS, and Treasuries. After losing over 2.5% in September alone, the Agg’s year-to-date return is now negative, while still ahead of duration-matched Treasuries.
Spreads widened in the quarter for short and intermediate corporates while tightening on the long end. Current-coupon MBS spreads also tightened.
IG corporate returns were weak while outperforming duration-matched Treasuries. Lower-rated IG corporates outperformed higher-rated corporates on an absolute basis. Relative to Treasuries, AAAs, and BBBs were the top-performing ratings categories.
Spreads tightened in most IG sectors in the third quarter. Consumer Cyclicals and Financials were the only sectors to realize wider spreads. Year-to-date spreads are tighter for every sector aside from Financials, which are flat for the year.
High Yield
CCC-rated corporates were the top-performing HY ratings category for the quarter and year-to-date on both absolute terms and relative to Treasuries. Spreads widened slightly in the quarter for all ratings categories but remain tighter year-to-date.
Changes in spreads varied widely by sector. The top performing sector was Technology, while the weakest sector was Transportation.
The number of HY issuers in default jumped higher in September, leading to a slight increase in the HY default rate for the quarter.
Municipals & Other
Municipal bonds returns were weak in the quarter. Year-to-date returns moved into negative territory across all duration categories. Yields moved higher across every ratings and maturity bucket.
Leveraged loans were relatively strong in the quarter, while preferreds, convertibles, and global Treasuries were weak.
This update provides an overview of certain broad-based Fixed Income benchmarks and does not include performance of the Segall Bryant & Hamill Fixed Income styles. Past performance cannot guarantee future results. All investments involve risk, including the possible loss of capital. All opinions expressed in this material are solely the opinions of Segall Bryant & Hamill. You should not treat any opinion expressed as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of the manager’s opinions. The opinions expressed are based upon information the manager considers reliable, but completeness or accuracy is not warranted, and it should not be relied upon as such. Market conditions are subject to change at any time, and no forecast can be guaranteed. Any and all information perceived from this material does not constitute financial, legal, tax or other professional advice and is not intended as a substitute for consultation with a qualified professional. The manager’s statements and opinions are subject to change without notice, and Segall Bryant & Hamill is not under any obligation to update or correct any information provided in this material.
1 Source: Bloomberg.
2 Source: Bank of America Merrill Lynch.
3 Hypothetical yields are calculated as the AA municipal yield divided by (1-tax rate). Actual tax-adjusted yields will depend on individual tax circumstances.
4 Source: Standard & Poor’s.