Ten months into 2023, the fixed income market appeared poised for its third consecutive yearly decline, with the Bloomberg U.S. Aggregate Index (the Agg) sitting at a year-to-date loss of -2.8%. At the beginning of November, however, the Treasury Department announced it would focus largely on short-term issuance for upcoming government funding needs. In addition, based on the Federal Reserve’s (Fed) comments and interest rate projections (the “dot plot”), the market began pricing in numerous interest rate cuts in 2024.

Against that backdrop, the Agg came roaring back, posting the strongest rolling two-month return since 1982 and pushing the Agg to a full-year gain of 5.5%. Every sub-sector of the Agg generated positive returns for the year while outperforming similar-duration Treasuries. The top performing sub-categories of the Agg were long corporates and mortgage-backed securities.

Corporate bond spreads ended the quarter and full year tighter than where they began, contributing to strong returns in risk assets, including both investment grade (IG) and high yield (HY) corporates. HY bonds were particularly strong, as every HY ratings category finished the year with double-digit returns. Despite the general strength in HY bonds, the HY default rate jumped in December, finishing the year at 3.8%, approaching the long-term average of 4.1%.

Read on for further analysis of the fixed income market in the fourth quarter.

Fixed income markets rallied in the fourth quarter, with every major sub-category generating strong gains.

Treasury yields declined across the curve. Aside from the shortest part of the curve (inside one year), Treasury yields ended the year at levels very near where they began 2023.

Treasury returns were strong across the curve, with particularly strong performance on the long end.

The Agg enjoyed the strongest quarterly return since 1989 ending the year with respectable gains. Every sub-component finished the year with positive returns and outperformed similar-duration Treasuries, led by long corporates which returned over 14% in the quarter.

Investment grade spreads tightened in the quarter and the full calendar year.

All IG ratings categories posted strong fourth quarter absolute returns while also outperforming Treasuries.

Spreads tightened across every investment grade sector for the fourth quarter and the full year. The most significant tightening occurred in Communications bonds for both the quarter and calendar year.

High yield corporates performed well in the quarter, capping off a strong year. Every HY ratings category finished the year with tighter spreads and double-digit returns, outperforming similar-duration Treasuries by over 300 basis points.

Spreads tightened across every high yield sector other than Transportation. The most significant tightening for the quarter and year came from the Financials sector.

The total number of HY issuers in default rose by three in December and 17 for the full calendar year. At 3.8%, the HY default rate is approaching the long-term average of 4.1%.

Municipal bonds had a strong fourth quarter and finished the year with positive returns. Yields fell across every ratings and duration category.

Performance was strong among other fixed income sectors, including emerging markets, leveraged loans, convertibles, etc.