Fourth Quarter Crosscurrents: Fed Cuts, Yields Rise, and D.C. Shifts

Fixed income returns were broadly negative in the fourth quarter, with the Bloomberg U.S. Aggregate Bond Index (the Agg) declining by 3.06%. Before 2021, Agg had not seen a calendar quarter loss exceeding 3% since 1981. Remarkably, this has now happened six times in the past four years. The disappointing fourth-quarter performance followed a strong +5.20% return in the third quarter of 2024, which ranked as the third-highest quarterly gain for the index in the last 23 years.

 

Although the Federal Reserve (Fed) cut rates at both meetings during the quarter, Treasury yields moved decidedly higher. The Fed hinted that rate cuts are likely to slow in 2025, in reaction to recent inflation trends. In addition, investors appeared wary of fiscal policies out of Washington that could put upward pressure on inflation.

 

The Agg finished the full year with a 1.25% gain, outperforming similar-duration Treasuries by 78 basis points (bps). Corporate bond spreads tightened across nearly every sector for the quarter and full year. The only sub-sector of the Agg to underperform similar-duration Treasuries for the year were mortgage-backed securities (MBS). The high yield default rate moved higher in the quarter, although it remains lower than where it began 2024.

 

Looking forward, policy announcements from the new administration in the United States will be closely monitored for their potential impact on businesses, inflation, Fed policy, etc. Meanwhile, global central banks are grappling with similar inflationary dynamics as seen in the United States, and their decisions will impact the U.S. dollar and the relative appeal of U.S. assets.

 

Read on for additional details and analysis from the fourth quarter of 2024.

Market Summary

Despite a rough final quarter of 2024, all the major fixed income sectors finished with positive absolute returns for the calendar year. High yield was the top-performing broad sector.

U.S. Treasury Market

The Treasury curve steepened in the quarter. Yields on T-bills fell, while yields rose on every Treasury maturity longer than 1 year.

    Returns on Treasuries were negatively correlated with their duration profile. T-Bills were the top-performing category for the quarter and full year, while the opposite was true for long Treasuries.

      Broad Investment Grade

      The Agg continued its run of volatility, giving back over 3% in the quarter but retaining a positive absolute return for the year and outperforming similar-duration Treasuries. Mortgage-backed securities were one of the worst-performing sub-sectors, and the only sub-sector to underperform similar-duration Treasuries for the quarter.

        IG corporate spreads were flat to wider in December but finished tighter quarter-over-quarter.

          IG corporate returns were negative in the quarter while beating similar-duration Treasuries. Returns—both absolute and excess—favored the lower-quality ratings categories.

            Corporate sector spreads either moved slightly wider or paused their tightening in December. Every sector finished the quarter tighter than where they began.

              High Yield

              High yield corporates outperformed Treasuries for the quarter and year, and were among the topperforming fixed income categories for the year. Spreads widened in December but finished the quarter tighter, most notably in the CCC ratings category.

                High yield spreads widened across every sector aside from Technology in December. For the full quarter, spread moves were mixed. Transportation and Communications sector spreads tightened the most, while Capital Goods and Utilities sector spreads widened the most.

                  The number of issuers to have defaulted in the past 12 months moved higher by 5 for the quarter.

                    Municipals & Other

                    Municipal bonds posted a loss in the quarter but finished the year with a positive return. Yields moved higher for nearly every ratings and maturity category.

                      Among the “other” fixed income sectors, emerging market bonds and leveraged loans posted positive returns in the quarter. Global IG Treasuries were the lone category to post a loss for the full year, while outperforming U.S. Treasuries.

                        Bond Rating Categories
                        Standard & Poor’s Ratings Group

                        AAA An obligation rated “AAA” has the highest rating assigned by Standard & Poor's. The obligor's capacity to meet its financial commitment on the obligation is extremely strong.

                         

                        AA An obligation rated “AA” differs from the highest rated obligations only in small degree. The obligor’s capacity to meet its financial commitment on the obligation is very strong.

                         

                        A An obligation rated “A” is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher- rated categories. However, the obligor’s capacity to meet its financial commitment on the obligation is still strong.

                         

                        BBB An obligation rated “BBB” exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.

                         

                        Obligations rated “BB,” “B,” “CCC,” “CC” and “C” are regarded as having significant speculative characteristics. "BB" indicates the least degree of speculation and “C” the highest. While such obligations will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposures to adverse conditions.

                         

                        BB An obligation rated “BB” is less vulnerable to nonpayment than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial or economic conditions which could lead to the obligor’s inadequate capacity to meet its financial commitment on the obligation.

                         

                        B An obligation rated “B” is more vulnerable to nonpayment than obligations rated “BB,” but the obligor currently has the capacity to meet its financial commitment on the obligation. Adverse business, financial or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitment on the obligation.

                         

                        CCC An obligation rated “CCC” is currently vulnerable to nonpayment and is dependent upon favorable business, financial and economic conditions for the obligor to meet its financial commitment on the obligation. In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation.

                         

                        CC An obligation rated “CC” is currently highly vulnerable to nonpayment.

                         

                        C A subordinated debt obligation rated “C” is currently highly vulnerable to nonpayment. The “C” rating may be used to cover a situation where a bankruptcy petition has been filed or similar action taken, but payments on this obligation are being continued.

                         

                        D An obligation rated “D” is in payment default. The “D” rating category is used when payments on an obligation are not made on the date due even if the applicable grace period has not expired, unless Standard & Poor's believes that such payment will be made during such grace period. The “D” rating also will be used upon the filing of a bankruptcy petition or the taking of a similar action if payments on an obligation are jeopardized.

                        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. Index performance does not reflect fees or expenses that investors typically pay to buy or sell securities. It is not possible to invest directly in an index.

                         

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                        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.