Fixed income update: Volatility subsides, risks remain

• Fixed income markets grappled with mixed signals from economic data and lingering concerns over the stability of the banking sector although volatility declined from the previous month.
• In the government bonds of developed markets, yields in the euro area and the UK rose amid concerns over persistent inflation. In the US, the Treasury yield curve continued to steepen.
• In credit markets, yield spreads tightened broadly across the board, reflecting a rebound in confidence in the market.

Fixed income markets grappled with mixed signals from economic data and lingering concerns over the stability of the banking sector following the failure of First Republic Bank in April, although volatility declined from the previous month¹. A cooling off in inflation data led to markets pricing in a pause in the US Federal Reserve’s (Fed’s) cycle of rate hikes, although the Fed did ultimately raise its federal funds rate by 25 basis points (bps) at its May meeting.

Meanwhile, a cut in oil production by the OPEC+ group of oil-exporting countries at the start of the month caused a spike in the price of oil, although this had tapered off by the end of the period. Discussions around the federal government debt ceiling by US lawmakers added to the uncertainties facing bond investors in April².

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, 31 March 2023 to 28 April 2023. Bloomberg indices are used as proxies for each exposure.

Government bonds

In the government bonds of developed markets, yields in the euro area and the UK rose amid concerns over persistent inflation. In the US, the Treasury yield curve continued to steepen; this was caused by a decline in front-end yields, as data published during the month showed that US inflation was lower than expected, driven by falling energy prices and rental inflation³.

Credit markets

In credit markets, yield spreads tightened broadly across the board, reflecting a rebound in confidence in the market following the onset of issues in the banking sector the previous month. Spreads in US dollar, euro and sterling investment-grade credit tightened by 4bps, 2bps and 16bps respectively in April⁴. In emerging market (EM) credit, investment-grade spreads tightened by 11bps, while high-yield spreads were broadly flat for the month⁵.

Changes in credit 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. J.P. Morgan EMBI Global Diversified IG Sovereign Spread Index, J.P. Morgan EMBI Global Diversified HY Sovereign Spread Index. Data from 31 March 2023 to 28 April 2023.

Amid fragile fund flows, ongoing quantitative tightening by major central banks and sizeable upcoming government and corporate bond issuance, we maintain our negative outlook on the technical backdrop for credit. Fund flows into investment-grade funds moved into positive territory during the second half of April, although we expect them to remain unstable and dependent on the trajectory of government rates markets as well as volatility. Issuance in April was on par with levels seen during the month in previous years. Euro-denominated investment-grade corporates issued a total of €39 billion during the month. Meanwhile, the sterling-denominated primary issuance market saw one of its quietest months on record, with just £1.5 billion in issuance in April.

Emerging markets

EM credit bond returns were broadly flat in April (0.5%) and were characterised by the continued divergence between investment-grade and high-yield performance, as well as a high degree of dispersion among individual country returns. EM credit returns were driven mostly by the Treasury component (0.4%), as US Treasury yields ended the month modestly lower. EM index-level spreads were largely unchanged for the month⁶.

Emerging market bond spreads

Sources: Bloomberg, JP Morgan and Vanguard, 29 May 2020 to 28 April 2023.

EM credit technicals improved in April relative to the previous month as moderating outflows were offset by large negative net issuance. The technical tailwind of negative net issuance has arisen because many high-yield EM issuers remain without market access, owing to high and rising borrowing costs, while high-grade issuers continue to reign in fiscal deficits compared with prior years. EM hard-currency fund outflows of -$1.5 billion were more than offset by negative net issuance of -$8.8 billion in April. We expect the market to remain technically well supported as a record-high proportion of total expected issuance was completed in the first quarter of the year and funding costs are set to remain high, which should continue to restrict market access.

Outlook

The narrative driving credit markets in 2023 has continued to be volatile. Recent supportive action by central banks has continued to improve market confidence, which has been bolstered by the view that recent stress in the banking sector has been idiosyncratic—rather than systemic—in nature. Despite this growing confidence, we believe that growth is likely to slow, as the effect of central bank tightening impacts issuers and the cost of funding. We are beginning to see a decoupling of economic and asset price expectations. As inflation remains persistent, it is conceivable that central banks will have to continue raising interest rates to combat rising prices. However, asset prices are starting to reflect concerns around a possible recession, particularly amid fears that any recession could occur sooner and be deeper than previously expected as financial conditions tighten in the real economy.

In EMs, we maintain our positive outlook for the asset class as it remains supported by a maturing monetary policy cycle, attractive yields (8.5%⁷ at the index level) and a supportive technical backdrop, although we are starting to see less attractive valuations within EM investment-grade bonds. EM high-yield has been performing well recently, and we have also observed select opportunities within the local-currency-denominated market.

¹  Source: Bloomberg as at 28 April 2023.

² Source: Vanguard.

³ Source: Bloomberg as at 28 April 2023.

⁴ Source: Bloomberg Global Aggregate Credit Index as at 28 April 2023.

⁵ Source: JP Morgan EMBI Global Diversified Index as at 28 April 2023.

⁶ Source: JP Morgan EMBI Global Diversified Index as at 28 April 2023.

⁷ Source: JP Morgan EMBI Global Diversified Index as at 28 April 2023.