October was a turbulent month for global bond markets as a sell-off in US Treasuries and geopolitical concerns in the Middle East caused a spike in volatility, particularly at the longer end of the yield curve. In the US, 10-year Treasury yields surpassed 5% for the first time since 2007. Markets began to stabilise towards the end of the month amid expectations that the US Federal Reserve (Fed) would continue to pause its cycle of interest rate hikes.  

The US economy remained resilient in the third quarter as gross domestic product (GDP) rose 2.9% on an annualised basis and retail sales exceeded forecasts. In Europe, the growth picture told a different story, as euro-area GDP grew only 0.1% on an annualised basis, with manufacturing and services activity coming in below expectations. 

At its October meeting, the European Central Bank left its key policy rate unchanged at 4% following an unprecedented ten consecutive rate hikes. The Fed and Bank of England followed suit in early November, opting to hold their respective key interest rates at current levels. 

Meanwhile, the Bank of Japan (BOJ) fuelled rumours that it may loosen its yield curve control policy, after altering a reference to its 1% limit on 10-year Japanese government bond yields as a ‘reference point’ rather than a ‘hard cap’, in a  statement by BOJ Governor Kazuo Ueda last month.    

Monthly performance by market

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Source: Bloomberg. For the period 30 September 2023 to 31 October 2023. Bloomberg indices are used as proxies for each exposure.

Government bonds

Developed market government bond yield curves steepened in October as investors priced in expectations that rates will be held higher for longer to tackle inflation. In the US, 2-year and 10-year yields rose by 4 basis points (bps) and 8 bps, respectively. In Europe, German 2-year Bund yields fell by 19 bps while 10-year yields fell by 3 bps. In the UK, 2-year gilt yields fell by 12 bps while 10-year yields rose by 8 bps¹.

Credit markets

Credit funds suffered outflows in October, driven by the heightened risk-off sentiment in core government bond markets and exacerbated by the conflict in the Middle East. Investment-grade spreads in the US, UK and euro area widened by 8 bps, 7 bps and 7 bps, respectively². In emerging markets (EM), investment-grade and high-yield spreads widened by 1 bp and 3 bps, respectively³. Global high-yield spreads saw the largest widening, increasing by 40 bps during the month⁴.

Changes in spreads 

Source: Bloomberg indices: Global Aggregate Credit Average OAS Index, Global Aggregate Supranational Index, US Aggregate Corporate Average OAS Index, Euro Aggregate Corporate Average OAS Index, Sterling Aggregate Corporate Average OAS Index, US Aggregate ABS Average OAS Index, US Aggregate CMBS Average OAS Index, Global High Yield Average OAS Index, JP Morgan EMBI Global Diversified IG Sovereign Spread Index, JP Morgan EMBI Global Diversified HY Sovereign Spread Index. Data for the period 30 September to 31 October 2023.

With third-quarter earnings season in full swing during October, there were initial signs of an economic slowdown beginning to impact corporate earnings – particularly in sectors such as basic materials, industrials and consumer discretionary, where many firms reported missing analyst forecasts. Meanwhile, financials largely beat expectations as banks continued to benefit from higher interest rates and provisions for loan losses remained at low levels. 

Emerging markets 

EM credit declined -1.35% in October as US Treasury losses impacted EM credit returns. Spreads remained resilient, widening by 5 bps during the month⁵, supported by strong supply and demand dymanics.  

Emerging market bond spreads

Source: Bloomberg, JP Morgan, with Vanguard calculations; for the period 31 December 2022 to 31 October 2023. 

EM investment-grade bonds underperformed high-yield bonds due to their higher sensitivity to US Treasuries. EM local-currency bonds fell -0.5%⁶, driven by EM currency losses of 0.6% against the US dollar, which rallied during the month due to rising US yields and investors’ reduced risk appetite. 

Outlook  

Overall, our outlook for developed market investment-grade bonds remains positive, supported by higher starting yields, central banks that are likely nearing the end of their hiking cycles and a weaker global economy that is not yet recessionary. Historically, investment-grade yields at these levels have been followed by strong returns over the next six to 12 months. Within investment grade, we remain selective and view the ‘belly’ of the yield curve (maturities of 5-10 years) as more attractive than shorter maturities. In high-yield, we’ve seen an uptick in default activity and expect this to continue as fundamentals weaken. Looking ahead, we expect investment-grade bonds to rally in a risk-off scenario; while inflows into more risky assets are likely to remain subdued as markets continue to grapple with macroeconomic and political uncertainties. 

In EM, investment-grade sovereigns should remain defensive in a more challenging macroeconomic environment, but some areas of the market look very expensive from a spread perspective. EM high yield has performed well this year and supply remains constrained – as a result, valuations continue to look tightly-priced. Overall, we remain constructive on EM credit given its high overall yields, relatively supportive technicals and the prospect of a return in investor inflows. We expect return dispersion to increase as the economic cycle matures and the market punishes credits with poor fundamentals.

¹ Data for 2-year and 10-year yields for US Treasuries, German Bunds and UK gilts are from Bloomberg; for the period 30 September 2023 to 31 October 2023. 

² Source: Bloomberg Global Aggregate Credit Index; 30 September 2023 to 31 October 2023.

³ Source: JP Morgan Emerging Market Bond Index (EMBI) Global Diversified index; 30 September 2023 to 31 October 2023. 

⁴ Source: Bloomberg Global High Yield Average OAS Index; 30 September 2023 to 31 October 2023.  

⁵ Source: Vanguard and JP Morgan. Average spread calculations based on the JP Morgan EMBI Global Diversified index relative to US. Treasuries. Monthly change in spread is for the period 30 September 2023 to 31 October 2023.  

⁶ Source: JP Morgan EMBI Global Diversified index; 30 September 2023 to 31 October 2023.