Themes, outlook, and investment implications across global fixed income markets

Principal Fixed Income

Fixed income perspectives

Looking ahead at 2Q 2024: A pause before a pivot

Uncertainty surrounding the timing and depth of prospective rate cuts has risen and the resilience of the economy has been surprising. However, we believe evidence of lagged policy transmission will further reveal itself over 2Q.

U.S. outlook

As Federal Reserve (Fed) policy has shifted from a historically aggressive series of rate hikes to a pause phase, market participants are now looking forward to the start of a rate cut cycle. However, the timing and magnitude of cuts will be determined by the evolution of inflation and employment. The Federal Open Market Committee’s (FOMC) preferred gauge for inflation is year-over-year core personal consumption expenditures, which currently stands below 3%. The Fed has said that they intend to begin the process of reducing rates before the 2% goal is achieved, supporting recent guidance of rate reductions beginning around mid-year. To the surprise of many, the U.S. jobs market has been incredibly resilient, but the bulk of the growth in the jobs market has been part-time workers with full-time employment in the household survey peaking in the summer of 2023 and steadily declining since. Leading indicators of the labor market—temporary employment, average weekly hours, overtime hours, and aggregate hours—have all been declining, consistent with prior late-cycle activity. If inflation continues to improve, a resilient jobs market won’t preclude the FOMC from beginning to reduce rates, but a deterioration in jobs would increase expectations for the magnitude of cuts.

Global outlook

Led by the Fed, an almost unanimous pushback by global central banks against market expectations of imminent rate cuts has been the dominating theme driving the market so far this year. Reinforced by tight labor market data and a rebound in core inflation data, the market repriced U.S. rate cuts for 2024 from over six cuts for the year to just three. Underneath the consensus expectations of a soft landing—a view echoed by the G20 and International Monetary Fund (IMF)—there are signs of lagged policy transmission quietly working through the economy. Global central banks have cited uncertainty over continued improvement in inflation data and concerns about a stronger dollar bringing imported inflation and lifting inflation expectations in their respective economies as reasons for their joint pushback on rate cut expectations. Regulators are warning banks to increase provisions and reduce leverage provided to households and real estate-related lending— normal reaction functions of banks and borrowers as higher policy rates filter through to the broader economy—but this will continue to anchor growth and inflation pressures over the course of the year despite the recent upticks.

Source: Bloomberg. As of February 27, 2024.

Owners’ equivalent rent (OER)—a key indicator of inflation—has been noisy over 1Q, however, other leading inflation indicators suggest there’s OER improvement to come. This is supportive of a continued downward trend in inflation.

With market expectations shifting toward a soft landing, credit spreads are likely to remain rangebound, exhibiting a widening bias as a recession becomes more evident.

Though economic data has been resilient, key market indicators continue to signal an impending recession, and we strongly believe there is further economic slowing on the horizon.

Download full report (PDF)

U.S. Zillow Rent Index, all homes, MoM

U.S. CPI Urban Consumers Owner Equivalent Rent of Residenes, SA

-0.50

0.00

0.50

1.00

1.50

2.00

Zillow rent index (MoM)

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

CPI owners equivalent rent (3m annual %)

2019

2020

2021

2022

Download full report (PDF)

Fixed income perspectives, 2Q 2024

While volume is up in the syndicated loan market to start the year, much of this is refinancing and repricing of existing loans. Though new loan volume origination for private middle market direct lending has been somewhat below the expected full year 2024 pace, the volume that is being realized continues to present attractive value. Easing credit conditions may contribute to the resiliency of the economy and ultimately borrower performance through the cycle. As the market may be getting ahead of itself in anticipating a soft landing, lenders must remain focused on underwriting through a potentially challenging cyclical downturn. Continued economic uncertainty is contributing to several supportive trends for middle market direct lending and ultimately an opportunity to enhance risk-adjusted returns relative to historic loan vintages.

On the back of slowing developed market (DM) growth and stabilizing emerging market (EM) growth, EMs are set to increase their growth outperformance versus DMs in 2024. We expect 2024 to be an intense year of elections across the EM countries. In addition, the outcome of the U.S. election could have deep implications for global geopolitics including shaping the way forward in the current wars between Russia-Ukraine, the Middle East, and U.S.-China strategic competition, as well as the broader relationships between the global south and the West and between Western allies themselves. Away from primary EM markets, we see the potential for select distress stories to find new life and possibly return to normal trading markets. Overall, our base case into 2024 remains optimistic on the EM sector. As always, top-down sovereign and bottom-up corporate analysis and issue selection will be keys to performance.

After resounding victories by both party candidates in state primaries and caucus elections to date, markets are starting to ponder the implications of the evolving political landscape as the presidential election has again come to the forefront. Key policy issues will be impacted depending on which party controls the White House and Congress, likely resulting in substantial volatility. Chief among those issues are the expiring tax provisions of the 2017 Tax Cuts and Jobs Act (TCJA). TCJA overhauled the individual tax code, cutting taxes across all income groups and is set to sunset in 2025, meaning the next administration will have some difficult decisions to make. We see three probable election themes taking root in municipal markets over 2Q 2024:

A confluence of factors including bank demand, lower cash rates, and attractive spreads suggest the mortgage-backed securities (MBS) sector is primed for performance for the balance of 2024. With that said, we believe the performance of the MBS basis and production coupons is increasingly tied to the Fed outlook. For the asset-backed securities (ABS) sector, a unique combination of credit and technical factors has resulted in an opportunity to add high-quality, short-duration residential MBS as assets are expected to provide relatively stable performance across varying market scenarios. As we entered 2024, the tone for commercial mortgage-backed securities strengthened. We see attractive value in single asset single borrower loans, which offer exposure to specific property types in lower-leveraged, higher-quality commercial real estate.

Despite ongoing geopolitical tensions and macroeconomic challenges (including stubborn inflation and shifting rate cut expectations), we remain positive about the prospects for high yield (HY). Admittedly, spreads are tight today, and we anticipate a slight widening through 2024. However, the asset class continues to offer a substantial amount of income, especially as default rates decline. In terms of the maturity ladder, we do not view the approaching wave of bond maturities as a significant risk to the HY asset class. Despite an increasing volume of maturities extending into 2028, the market for new HY issues remains accessible for companies not experiencing long-term secular declines or facing specific idiosyncratic risks. We fully acknowledge that companies may default for reasons beyond approaching maturities, but we don't see the upcoming maturity wave as a significant obstacle for the HY asset class.

Similar to the way a stock price embeds expectations of a company’s future earnings, today’s corporate bond market appears to be pricing in expectations of future flows into the credit market. Even as spreads are pinned at tighter levels, money continues flowing into the asset class, and new bond deals are readily absorbed by investors focused on yields. Notably, the near-to-medium term expectation of money coming into investment grade (IG) credit is creating the receptive risk tone amid these tighter spreads. Investors are clamoring for corporate bonds, and the surging supply seen so far has come in response to demand. For the time being, yield—not spread—is driving this market as IG credit draws the attention of institutional investors. The year began with a pair of ~$200 billion new issue months (both record months), with February marking the fifth most active supply month ever. March supply followed suit with over $140B in new issuance, surpassing monthly estimates and setting a 1Q record for primary volume. The robust demand appears driven by both enticing yields and impending Fed rate cuts. Higher Treasury yields are supportive of IG spreads, and yield-focused buyers make up 60% of institutional fixed income investors.

Private credit

Emerging market debt

Municipals

Securitized debt

High yield credit

01

While economic challenges remain, we see opportunities in fixed income.

Investment implications

Bloomberg U.S. Corporate Bond Index

Source: Bloomberg. As of February 29, 2024.

Maturity wall by quality, Bloomberg U.S. Corporate High Yield - 2% Issuer Capped Index ($B)

Download full report (PDF)

Download (PDF)

Featured insights

Q3 2023

Source: Refinitiv. As of September 30, 2023. *Syndicated Middle Market: Facilities syndicated to at least one participant up to US$500M in deal size or clubbed up to US$150M in deal size. **Direct Lending: Non-syndicated facilities, no non-titled lender. Unitranche and bilateral loans, deals clubbed over US$150M deal size, facilities that go unreported, privately placed second-liens, mezzanine and seller notes.

Annual middle market leveraged buyout issuance ($B)

Unemployment claims remain low by historical standards, but signs of softening and a meaningful upsurge in claims could challenge the market consensus of a soft landing and increase pricing for the magnitude of cuts.

A confluence of headwinds, including depleting excess savings, tightening credit, and rapidly rising interest payments, could slow consumer spending, the main engine of economic growth.

Dec22 Jan23 Feb23 Mar23 Apr23 May23 Jun23 Jul23 Aug23 Sept23

High yield credit

Securitized debt

Municipals

Emerging market debt

Private credit

View next:

High yield credit

Securitized debt

Municipals

Emerging market debt

Private credit

Investment grade credit

Yield-to-worst, % (RHS)

Option-adjusted spread, bps (LHS)

View next:

Securitized debt

100

150

200

250

Source: Bloomberg. As of February 29, 2024.

View next:

Municipals

Indicative distribution of underlying mortgage rates

Principal balance (%)

Source: J.P. Morgan. As of February 29, 2024.

After resounding victories by both party candidates in state primaries and caucus elections to date, markets are starting to ponder the implications of the evolving political landscape as the presidential election has again come to the forefront. Key policy issues will be impacted depending on which party controls the White House and Congress, likely resulting in substantial volatility. With an ever-increasing federal deficit (the highest in U.S. history) revenue will be a priority no matter which candidate and party wins this fall. Individual income taxes, according to the Tax Foundation, are the highest source of revenue for the U.S. We do not see that changing, and we do not see individual tax rates going lower. In fact, we think the opposite, further enhancing the value of the exemption and leading to greater investor demand for the asset class.

View next:

Emerging market debt

Taxable equivalent yield advantage of municipals

Source: Bloomberg. As of February 29, 2024.

View next:

Private credit

Economic growth and inflation picture improving for EM

'08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19 '20 '21 '22 '23

Annual middle market leveraged buyout issuance ($B)

0.00

10%

20%

30%

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

% Syndicated

Source: LSEG LPC. As of December 31, 2023. *Syndicated Middle Market: Facilities syndicated to at least one participant up to U.S. $500 million in deal size or clubbed up to U.S. $150 million in deal size. **Direct Lending: Non-syndicated facilities, no non-titled lender. Unitranche and bilateral loans, deals clubbed over $U.S. $150 million deal size, facilities that go unreported, privately placed second-liens, mezzanine and seller notes.

30.00

20.00

10.00

40%

50%

60%

MM LBO volume ($B)

Syndicated*

Direct**

View last:

Emerging market debt

U.S. outlook

Download full report (PDF)

Leading indicators of the labor market in decline

Hover over key to isolate by term

1500

2000

3000

3500

1990 1995 2000 2005 2010 2015 2020

Source: Bloomberg. As of February 29, 2024.

Investment grade credit

02

03

04

05

06

Investment grade credit

Syndicated (%)

180 160 140 120 100 80 60 40 20 0

4.75 to 5.00 5.00 to 5.25 5.25 to 5.50 5.75 to 6.00 6.25 to 6.50 6.50 to 6.75 6.75 to 7.00 7.00 to 7.25 7.25 to 7.50 7.50 to 7.75 7.75 to 8.00 8.00 to 8.25 8.25 to 8.50 8.50 to 8.75

25 20 15 10 5 0

2020 2021 2022 2023

Download full report (PDF)

Principal Fixed Income

Fixed income perspectives

Themes, outlook, and investment implications across global fixed income markets

2Q 2024

Featured insights

Download full report (PDF)

1000

2500

>50bp hike 0-50bp hike pause 0-50bp cut >50bp cut

0 5 10 15 20 25 30

BBB

Emerging economies' real GDP (Annual YoY%)

Emerging economies' consumer price index (Annual YoY %)

-6.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035

Source: Bloomberg. As of December 31, 2023.

5.0

2.8

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035

Overtime hours

Recession

Average weekly hours (private)/ non-supervisory

Temporary hiring peaks

Past 6 months

By end of 2024

Number of economies (world) policy rate adjustment

Toggle to learn more.

Number of economies (G20)

Number of economies (world)

1-3Q

70%

40.00

50.00

60.00

70.00

80.00

90.00

$20.5

$11.6

$18.9

$19.4

$19.0

$23.8

$28.0

$27.1

$20.6

$35.7

$22.4

$30.6

$12.5

$23.8

$19.5

$57.9

$10.9

$44.6

$6.5

$26.5

-6.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

Emerging economies consumer price index (Annual YoY%)

Emerging economies real GDP (Annual YoY%)

Source: Bloomberg. As of December 31, 2023.

-4.00

Temporary payrolls, # of employees (thousands)

2.5

3.5

4.5

5.5

Average weekly hours (private) / non-supervisory

34.60 34.40 34.00 33.80 33.60 33.40 33.20 33.00

Overtime hours

Temporary payrolls

Overtime hours

Avg weekly hours (private)/non-supervisory

Number of economies (G20) policy rate adjustment

Past 6 months

By end of 2024

0 2 4 6 8 10 12

>50bp hike 0-50bp hike pause 0-50bp cut >50bp cut

Source: Bloomberg. As of February 27, 2024.

300

CCC

Below CCC

Borrowers with mortgages above the current rate

7 6 5 4 3 2 1 0

43.8% tax rate

40.8% tax rate

6.5 6 5.5 5 4.5 4

1 yr 2yr 3yr 4yr 5yr 7yr 10yr 15yr 20yr 25yr 30yr

Treasury

General obligation (AAA)

7 6.5 6 5.5 5 4.5 4

Divided government: With no single party determining policy, we expect the TCJA to expire, raising individual tax rates across all brackets. Top filers would see their rate rise back to 40%.

Democratic sweep: Under a “blue wave,” we see both individual and corporate tax rates increasing.

Republican sweep: Should a “red wave” occur, the expiring tax cuts would likely be extended, leaving the top marginal rate at the (still favorable) 37% level for individual muni buyers.

Temporary payrolls

Click key categories below to isolate by term

Reset to default

0 5 10 15 20 25 30

Number of economies (G20) policy rate adjustment

Dec22 Jan23 Feb23 Mar23 Apr23 May23 Jun23 Jul23 Aug23 Sept23

>50bp hike 0-50bp hike pause 0-50bp cut >50bp cut

0 2 4 6 8 10 12

Past 6 months

By end of 2024

Source: Bloomberg. As of February 27, 2024.

300

BBB

Taxable equivalent yield advantage of municipals

7 6.5 6 5.5 5 4.5 4

1 yr 2yr 3yr 4yr 5yr 7yr 10yr 15yr 20yr 25yr 30yr

Treasury

General obligation (AAA)

-4.00

>50bp hike 0-50bp hike pause 0-50bp cut >50bp cut

Treasury

General obligation (AAA)

1 yr 2yr 3yr 4yr 5yr 7yr 10yr 15yr 20yr 25yr 30yr

'08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19 '20 '21 '22 '23

4.75 to 5.00

5.00 to 5.25

5.25 to 5.50

5.75 to 6.00

6.25 to 6.50

6.50 to 6.75

6.75 to 7.00

7.00 to 7.25

7.25 to 7.50

7.50 to 7.75

7.75 to 8.00

8.00 to 8.25

8.25 to 8.50

8.50 to 8.75