Fixed Income Update | June 2023

June 2023

• Fixed income markets shifted focus away from bank turmoil and the debt-ceiling debate, with investors evaluating?economic growth, inflation trends, and the Federal Reserve’s (“Fed”) June 14 meeting results, quarterly year-end rate projections (“DOTS”), and commentary.
• After 10 consecutive interest rate hikes totaling +5.00%, the Fed “paused” on June 14th, leaving their policy rate unchanged at +5.25%, but signaled that they are likely to enact several more hikes like this year.
• Treasuries were mostly lower in June, as investors digested the impact of stubborn inflation and further interest rate increases. Year-to-date, Treasuries have delivered positive returns, with volatility in the longer-duration tranches (Table 2).
• Spread-based assets delivered their best performance since January, with U.S. high yield and emerging markets leading in June, returning +1.6% and +2.0% for the month. Both groups also lead returns year-to-date, with high yield at +5.3% and emerging market debt at +3.6% (Table 1).
• A rally in equity markets boosted valuations in credit, helping drive spreads tighter in investment grade corporate and high yield markets. The equity rally is also adding strength to consumer balance sheets and propping up spending.
• In economic news, employment and consumer spending remained strong, price growth moderated, and the probability or depth of a U.S. recession is being hotly debated among market prognosticators.

Chart 1, 2 and Table 1 Sources: ICE Data Services, JP Morgan, Bloomberg | Data as of 6/30/2023. Past performance is no guarantee of future results. See important disclosures and definitions at end of document.?

• With the regional bank and debt crisis averted in early 2023, rates markets in June returned their focus to the Fed policy actions, comments, and the U.S. economic outlook.
• At the June 14th meeting, the Fed left their policy rate unchanged at the range of 5.00%-5.25%, saying they wanted to assess the lagged affects of the previous 10 rate hikes, but that they were prepared to take stronger action in the future to get inflation back down to their +2.0% target annual growth rate.
• Concurrently, the Fed released their quarterly year-end rate projections, surprising many investors by raising their median 2023 and 2024 rate forecasts. The year-end 2023 forecast rose by 50 basis points to 5.625%. Data and Fed comments drove Treasuries lower in the 2-to-10-year duration range (Chart 3, Table 2).
• Although economic growth has slowed, data has continued to come in above expectations, including 3.7% unemployment, +4.3% growth in average annual earnings, an upward revision to first quarter GDP and personal consumption, as well as a surprising jump in new home construction.
• Today, Fed Funds futures are pricing in at least one more 25 basis point hike in policy this year, although predictions continue to drift higher (Chart 4). The DOTS imply two more 25 basis point hikes.?

Chart 3, 4 and Table 2 Sources: Bloomberg | Data as of 6/30/2023. Past performance is no guarantee of future results. See important disclosures and definitions at end of document.?

• Emerging Market (“EM”) debt reported its best month since January, with a +2.0% total return, as investors turned their focus to income-generating assets, restructuring situations, strong U.S. growth, and a visible end to Fed rate increases.
• EM spreads experienced the most tightening in June of any month in 2023, as EM debt with maturities under 10 years reported spreads 60 basis points tighter during the month (Table 3).
• Year-to-date, EM debt has returned +3.6%, second only to U.S. high yield when compared to other US-dollar fixed income assets, though EM debt still provides some of the highest yields in fixed income (Table 1, Chart 6).
• While lower oil prices have provided some headwinds to EM issuers, especially those in the Middle East, continued weakness in the U.S. dollar has provided implied fiscal support to countries issuing debt in USD.
• Lower-rated EM debt has led returns in June, the second quarter, and year-to-date, rising nearly +5.0% for the six-month period, compared to +3.4% for investment grade-rated EM debt (Chart 5, Table 3).
• Several distressed issuers, including Pakistan and Zambia, reached restructuring agreements with the International Monetary Fund and creditors, providing clarity on their ability to repay investors, while helping boost returns of similar issuers.

Chart 5, 6 and Table 3 Sources: J.P. Morgan | Data as of 6/30/2023. Past performance is no guarantee of future results. See important disclosures and definitions at end of document.

• Positive returns were experienced by each of three high yield credit rating categories in June, finishing off a strong first half for U.S. high yield as the performance leader among domestic fixed income asset classes (Chart 7, Table 1, Table 4).
• The CCC-rated sector was up an impressive +3.3% in June, its third strongest month since June 2020, as it more than recovered from its -1.1% loss in May (Chart 7, Table 4).
• With June’s performance, the CCC-rated sector increased its year-to-date outperformance versus both BB’s and single-B’s, up 9.4% for the six months ended June 30th (Chart 7, Table 4). CCCs spreads tightened 229 over this time period.
• Single-B and BB-rated high yield bonds recorded year-to-date returns of +5.8% and +4.1%, respectively, including positive returns of +1.6% and +1.2% in June, as credit spreads tightened during the month (Chart 7, Chart 8, Table 4).
• Although new issue volume moderated in June, year-to-date new issue volume of $96 billion is running well ahead of last year’s volume at this time of $71 billion. However, year-to-date volume is still below the pace experienced in 2020 and 2021 (J.P. Morgan).
• Although default activity rose once again during June, the default rate of 2.7% for high yield is still below its long-term average (J.P. Morgan).

Chart 7, 8 and Table 4 Sources: ICE Data Services, Bloomberg | Data as of 6/30/2023. Past performance is no guarantee of future results. See important disclosures and definitions at end of document.?

• All seven high yield industry sectors generated positive total return performance in June, with Telecom, Media, and Technology experiencing the best performance for the month, up +2.3%, followed by the Financial/REIT sector, which was up +2.0% (Chart 9).
• The high yield rally during June was broad-based, as all industries except Consumer Non-Cyclical posted returns in excess of 1.0% (Chart 9).
• For the first half of 2023, the Consumer Cyclical industry was the performance leader among sectors, up +8.5%, with large issuers such as Ford, Carnival Corp. and Royal Caribbean boosting returns for the sector (ICE Data Services).
• Credit spreads for the Consumer Cyclical sector are an impressive 180 basis points tighter year-to-date, the largest spread move among all high yield industry sectors (Chart 10, Table 5).
• The next best sector in U.S. high yield during the first half was Core Industrial, up +5.8% and 92 basis points in spread, with contributions from issuers such as Transdigm, American Airlines, Bombardier and Ardagh boosting returns (ICE Data Services).
• Lagging performance among large issuers like DISH, CSC Holdings, Altice, and Frontier Communications has suppressed the year-to-date performance of the TMT sector, which has returned only 2.9% year-to-date (Chart 9, Table 5).

Chart 9, 10 and Table 5 Sources: ICE Data Services | Data as of 6/30/2023. Past performance is no guarantee of future results. See important disclosures and definitions at end of document.?

• The?Bloomberg U.S. Aggregate Index?is a broad-based flagship benchmark that measures the investment grade, US-dollar-denominated, fixed-rate taxable bond market.
• The?ICE BofA U.S. High Yield Index?tracks the performance of U.S. dollar-denominated, below investment grade-rated corporate debt publicly issued in the U.S. domestic market.
• The?ICE BofA Broad Market Index?measures the performance of U.S. dollar-denominated, investment grade debt securities, including U.S. Treasury notes and bonds, quasi-government securities, corporate securities, residential and commercial mortgage-backed securities and asset-backed securities.
• The?ICE BofA U.S. Corporate Index?tracks the performance of U.S. dollar-denominated investment grade rated corporate debt publicly issued in the U.S. domestic market.
• The?ICE BofA U.S. Treasury Index?tracks the performance of U.S. dollar denominated sovereign debt publicly issued by the U.S. government in its domestic market.
• The?ICE BofA Current 10-year U.S. Treasury Index?is a one-security index comprised of the most recently issued 10-year U.S. Treasury note.
• The?Bloomberg U.S. Treasury Target Duration Indexes?are a suite of 8 indices designed to target a specific duration using US Treasury securities. The 8 durations targeted are 6 Month, 1 Year, 2 Year, 3 Year, 5 Year, 7 Year, 10 Year and 20 Year.
• The?ICE Diversified U.S. Cash Pay High Yield Rating Category Indexes?contain all securities in the ICE BofA U.S. Cash Pay High Yield Index, broken down by their rating categories: BB1-BB3, B1-B3, and CCC1-CCC3. Index constituents are capitalization-weighted, based on their current amount outstanding.
• The?ICE Diversified U.S. Cash Pay High Yield Sector Category Indexes?contain all securities in the ICE BofA U.S. Cash Pay High Yield Index, broken down by industry including: Industrials; Telecom, Media & Technology; Healthcare; Financial & REIT; Energy; Consumer Cyclicals; Consumer Non-Cyclicals. Index constituents are capitalization-weighted, based on their current amount outstanding.
• The?Bloomberg A Corporate Index?measures the A-rated, fixed-rate, taxable corporate bond market.
• The?Bloomberg BBB Corporate Index?measures the BBB-rated, fixed-rate, taxable corporate bond market.
• The?Bloomberg Municipal Bond Index?covers the USD-denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and prefunded bonds.
• The?JP Morgan EMBI Global Diversified Index?tracks total returns for traded external debt instruments in the emerging markets, including U.S. dollar-denominated Brady bonds, loans, and Eurobonds with an outstanding face value of at least $500 million.
• The?J.P. Morgan 1-10 Year Emerging Markets Sovereign Index?tracks liquid, U.S. dollar emerging market fixed and floating-rate debt instruments issued by sovereign and quasi sovereign entities. The EMBIGDL 1-10 Index is based on the long-established J.P. Morgan EMBI Global Diversified Index and follows it methodology closely, but only includes securities with at least $1 billion in face amount outstanding and average life below 10 years.
• The?S&P 500 Index?tracks the performance of 500 leading large-cap U.S. equities and covers approximately 80% of available market capitalization.
• The?Bloomberg US Mortgage-Backed Securities Index?tracks fixed-rate agency mortgage-backed pass-through securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).
• The?NASDAQ Composite Index?measures all NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market, including over 2,500 companies, An investment can not be made in an index.
• Credit Spread: the difference in yield between a debt security and its benchmark measured in basis points
• OAS: Option Adjusted Spread. For a bond, the option-adjusted spread is the measurement of the spread between the bond and the underlying government yield curve. For an Index, the average of its constituent security government option-adjusted spreads, weighted by full market value.
• CPI Core / PCE Core: The Consumer Price Index excluding food and energy (CPI core) and the Personal Consummation Expenditures Price Index excluding food and energy (PCE Core) measures the prices paid by consumers for goods and services without the volatility caused by movements in food and energy prices to reveal underlying inflation trends. CPI sources data from consumers, while PCE sources from businesses.

Disclosures

There are risks associated with investing, including possible loss of principal. Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer's ability to make such payments will cause the price of that bond to decline. Securities that are rated below investment-grade (sometimes referred to as “junk bonds”) be deemed speculative, may involve greater levels of risk than higher-rated securities of similar maturity and may be more likely to default. Investing in mortgage- and asset backed securities involves interest rate, credit, valuation, extension and liquidity risks and the risk that payments on the underlying assets are delayed, prepaid, subordinated or defaulted on.

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Bond ratings are grades given to bonds that indicate their credit quality as determined by private independent ratings services, such as Standard & Poor’s, Moody’s and Fitch. These firms evaluate a bond issuer’s financial strength or it’s ability to pay a bond’s principal and interest in a timely fashion. Ratings are expressed as letters ranging from ‘AAA’, which are the highest grade, to ‘D’, which is the lowest grade.

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