Home etftrends.com Brighter Return Prospects Despite Rate Volatility – Fixed Income Outlook in 5...

Brighter Return Prospects Despite Rate Volatility – Fixed Income Outlook in 5 Charts

By Rob Williams, Director of Research

The latest inflation release illustrated the stickiness of inflation, particularly in core components like shelter and medical care. While we believe inflation will continue to trend lower, the pace of that deceleration will be slow, and inflation will remain above trend for some time. Growth data agrees with the notion of a recession, albeit a shallow one with a resilient labor market and service sector.

  • CPI Doesn’t Tell the Whole Story. Overall inflation is showing signs of peaking, with energy prices and other commodities dropping over the last several months. While this feeds into overall CPI, core prices are less influenced by this and are showing more of a flatlining pattern. Our base view is that overall inflation will continue to moderate, but core may remain stubborn due to certain lag effects in rents and labor markets.

Overall vs. Core CPI Inflation (YoY)
Source: Sage, Bloomberg

  • The Market is Pricing in an Aggressive Fed. The Fed is focused on suppressing long-term inflation expectations by tightening aggressively in the near-term. With the recent inflation figures, the Fed is expected to raise rates by 75 bps during the September FOMC meeting. The futures pricing of the Secured Overnight Financing Rate (SOFR) tells us how the market is pricing in the future federal funds rate. It’s pricing in an additional 175 bps through the end of 2022 to a 4.25% terminal rate for this hiking cycle, which may prove overly aggressive.

SOFR 3M Futures vs. Fed Funds Rate
Source: Sage, Bloomberg

  • Looking Past the Near-Term for Fixed Income. Slowly moderating inflation and pockets of strength in the economy will likely keep the Fed hiking rates fairly aggressively into year-end and will continue to pressure rates and fixed income returns in the near-term. Looking a little further out suggests we are approaching a strong period for fixed income, which has typically rebounded after negative returns, had strong returns following Fed cycles, and fared well in recessions.

Conditions for Bond Market Returns (Aggregate Bond Index)
Source: Sage, Bloomberg

*Assumes a -11% return in 2022

  • All-In Yield for IG Fixed Income – Highest in Over a Decade. Investment grade corporate bonds are now trading at over a 5% yield, the highest they’ve been in 15 years. Shorter maturity sectors offer a compelling entry point as yield per unit of duration has risen sharply.

Yield (bps) Per Year of Duration Short vs. Intermediate Bonds
Source: Sage, Bloomberg

  • MBS Spreads are Near the Widest Levels of the Year. The national average rate on a 30-year mortgage is now over 6%, the highest level since 2007. Nominal MBS spreads, specifically on higher coupons, remain very attractive, especially when compared to corporate credit.

MBS Nominal Spread vs. IG Corporate OAS (%)
Source: Sage, Bloomberg


Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

newETFs.io respects the hard work of others and gives all credit to the remarkable folks at ETFTrends.com. This excerpt/article was pulled from their RSS feed; click here to view the original. Please note that on occasion, the RSS feed will not have the author. When this happens this site defaults the author to "News". Make no mistake, this excerpt/article was not created by newETFs.io, it was simply shared with you.