Themes, outlook, and investment implications across global fixed income markets
Principal Fixed Income
Fixed income perspectives
Looking ahead at 4Q 2024:
Capturing fixed income opportunities as central banks shift gears
As the Federal Reserve embarks on its long-awaited rate-cutting cycle, the U.S. economy continues to display resilience despite mixed signals from global markets. Central banks worldwide are navigating their own paths toward monetary easing, but diverging approaches suggest an uneven road ahead.
U.S. outlook
The Federal Reserve’s stance has evolved significantly since 2023. At the Jackson Hole Symposium last year, Chair Jerome Powell highlighted the ongoing challenges with inflation and labor market rebalancing. However, by 2024, the tone has shifted, with inflation nearing the Fed’s 2% target and a renewed focus on preventing labor market cooling. In response, the Fed began cutting rates in September with a 50 bps reduction, marking the start of its rate-cut cycle.
Further rate cuts will hinge on labor market trends. If unemployment continues to rise and payrolls decline, the Fed may adopt a more aggressive stance, potentially pushing the Fed funds rate lower than the anticipated 3.25% by mid-2025.
A soft landing remains the base case, and much of the Fed’s easing is already reflected in market pricing. Yield curve steepeners, especially at the front end, offer strong opportunities, though outright duration positions are less attractive for now. Fixed income spreads are tight relative to historical norms, but they are supported by strong corporate profit margins. While risks such as geopolitical events and election volatility loom, healthy profit margins and limited recession risks provide a stable outlook for spreads in the near term.
Global outlook
Global markets have seen inflation moderate, allowing central banks to begin easing monetary policy. While the Federal Reserve was slower to start, waiting until September to begin its rate-cutting cycle, the forward path for the European Central Bank and the Bank of England is a less aggressive pace of monetary easing than that of the Fed. Outside the U.S., the Bank of Japan's July rate increase, though widely anticipated, triggered an unwind in the yen carry trade, leading to a sharp but short-lived market reaction. This move marked a turn in the dollar, aligning with the broader shift in global monetary policy, as the U.S. moves into its easing phase.
Historically, bond yields tend to decline during easing cycles, and current market expectations suggest a soft landing for the global economy. Although growth is expected to fall below potential, recession is not a requirement for bond yields to decline significantly. In fact, during the last three easing cycles before the pandemic, bond yields initially fell by 50 bps and, over time, by more than 100 bps. This trend should continue as central banks across developed markets ease policy. While risks remain, including elections and growth forecasts, the overall outlook for global fixed income performance remains positive as monetary policy continues to shift.
As we enter 4Q, central bank policies are diverging more clearly. The Fed initiated its rate-cut cycle in September, while the European Central Bank and the Bank of England are taking a more cautious, gradual approach.
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.
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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
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Fixed income perspectives, 4Q 2024
The private credit market has seen a notable uptick in deal activity, fueled by expectations of Federal Reserve rate cuts and improving economic stability. This trend is expected to continue through the remainder of 2024 and into 2025, with private direct lending playing an increasingly prominent role in financing M&A and leveraged buyout (LBO) transactions. As commercial banks and the public loan market become less attractive options for private equity sponsors, the middle market private credit space stands to gain momentum.
Credit conditions have eased, leading to tighter spreads across various segments of the private credit market. While large-cap private credit and public market spreads have tightened considerably over the past year, the lower and core middle market segments have also seen spread tightening, improving by approximately 75 basis points from 2023 highs. These tighter spreads, along with lower leverage levels, minimal payment-in-kind (PIK) features, and strong maintenance covenants, enhance the relative value of lower and core middle market lending opportunities for investors.
Despite a competitive environment in larger segments of the market, the lower and core middle market continues to offer strong value. With more resilient industries and first lien senior secured lending structures, middle market direct lending offers attractive risk premiums. Whether the Fed's rate path is measured or accelerated in response to economic volatility, private credit provides diversification and resilience, positioning it as a key area of opportunity for investors.
Emerging market (EM) economies remain well-positioned to navigate a developed market (DM) slowdown, with growth expected near 4% for 2024. Growth differentials between EM and DM are anticipated to improve in 2025, despite headwinds from a slowing China and broader DM weakness. Inflation should moderate across most EM regions, though Latin America and EMEA may see persistent inflation due to strong domestic demand and currency depreciation. China’s recent stimulus measures may support its equity market but are unlikely to reverse its structural slowdown.
Elevated DM interest rates have weighed on EM debt, contributing to significant outflows. However, the Fed’s policy pivot should reverse these flows starting in late 2024, with demand expected to pick up in 2025. Lower bond issuance and negative net issuance have mitigated the impact of outflows, and while supply may increase, it should remain manageable.
EM debt spreads are tight relative to history, with spreads likely to remain rangebound for the remainder of 2024, with volatility expected around the U.S. election. Although EM credit is less correlated to growth than EM currencies and equities, growth differentials will remain a key driver of investment flows into EM debt as we move into 2025.
Municipal bonds have remained attractive to investors throughout 2024, and the Fed’s easing cycle presents a unique opportunity to extend duration. While fundamentals in the municipal market are strong, with upgrades outpacing downgrades, technical factors have been a challenge. Municipal supply has surged, driven in part by election-related uncertainty, creating headwinds for the asset class.
However, as supply moderates in the fourth quarter, we expect municipal bonds to present a compelling opportunity for investors seeking tax-advantaged income. Historically, municipals have outperformed T-bills after the Fed begins cutting rates, regardless of whether the economy enters a recession or achieves a soft landing.
The current environment, with an elevated risk of recession but a base case for a soft landing, is particularly attractive for muni investors. With yields at some of the widest levels of 2024, now is an opportune time to lock in attractive, tax-advantaged income before the market prices in further Fed rate cuts.
Agency mortgage-backed securities (MBS) are uniquely positioned to benefit from a slowdown in the labor market and falling interest rates. With a government guarantee on credit risk, agency MBS tends to outperform other credit sectors during late-cycle economies or recessions.
One typical challenge for MBS during periods of falling rates is prepayment risk, as homeowners refinance to lower their mortgage costs. However, in the current market, this risk is muted by the unusually low rates locked in by many borrowers—most Fannie Mae mortgages are well below current rates, creating a significant cushion against refinancing.
Additionally, the technical backdrop for MBS has improved, with banks slowing their divestment from the sector. This has helped agency MBS outperform investment grade credit in recent months.
With rates continuing to fall and refinancing risks low, agency MBS offers investors a stable and defensive option, especially as demand for interest-rate-sensitive assets grows in response to the Fed’s rate cuts.
Despite a decline in yields, high yield (HY) bonds continue to offer attractive returns in the current environment. The Fed’s easing cycle, combined with solid fundamentals in HY companies, suggests that investors will continue to find value in this asset class.
Leverage ratios remain below historical averages, and interest coverage is well above long-term norms, signaling a healthy balance sheet for many issuers. The maturity wall for HY companies has been pushed out several years, which should keep defaults below historical levels even as the economy slows.
Strong inflows into HY have supported technicals throughout 2024, and as the Fed continues to cut rates, we expect deal activity to pick up, which could become a headwind if inflows slow. Yields approaching 7% continue to make HY an appealing choice for income-focused investors, though capital appreciation may be limited due to higher valuations.
Overall, HY remains well-positioned, and while spreads may widen slightly, strong fundamentals and technical factors suggest that total returns will remain competitive as the Fed’s easing cycle progresses.
Investment grade credit (IG) is set to benefit from the current environment of moderating growth, inflation, and interest rates. Despite an uptick in merger and acquisition activity, leverage among high-grade companies remains manageable, and investor demand for IG bonds has stayed robust. Corporate fundamentals are strong, supported by healthy balance sheets and solid income growth, creating a favorable backdrop for IG credit.
Yields, though down from recent highs, remain attractive on a historical basis, with spreads as a percentage of yield rising above 20%. As the Fed begins cutting rates, IG investors have absorbed a heavy supply of bonds, confident in the economy’s stability. Technical factors also support IG credit, with demand from both retail and institutional investors remaining strong, despite lower overall yields.
With the Fed now easing, we see opportunities to lock in attractive yields, particularly as the Fed's rate cutting cycle progresses. Investors should focus on issuers with solid credit metrics and de-leveraging discipline positioning portfolios to capture value before spreads potentially tighten further.
Private credit
Emerging market debt
Municipals
Mortgage-backed securities
High yield credit
01
While economic challenges remain, we see opportunities in fixed income.
Investment implications
Credit quality of the investment grade bond index
Source: J.P. Morgan, Bloomberg, Principal Fixed Income. Data as of April 30, 2024.
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Featured insights
Q3 2023
The U.S. labor market remains solid, but signs of cooling are emerging, particularly in payroll and unemployment trends. This could signal a broader economic slowdown, reinforcing the need for more accommodative monetary policy.
Despite potential volatility linked to the upcoming elections, fixed income markets are positioned for outperformance, with opportunities across municipal bonds, high yield, and other sectors as investors seek to capitalize on falling interest rates and favorable technicals.
High
yield credit
Mortgage-backed securities
Municipals
Emerging
market debt
Private
credit
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High yield credit
High
yield credit
Mortgage-backed securities
Municipals
Emerging
market debt
Private
credit
Investment
grade credit
BBB Total
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Mortgage-backed securities
Agency mortgage-backed securities (MBS) are uniquely positioned to benefit from a slowdown in the labor market and falling interest rates. With a government guarantee on credit risk, agency MBS tends to outperform other credit sectors during late-cycle economies or recessions.
One typical challenge for MBS during periods of falling rates is prepayment risk, as homeowners refinance to lower their mortgage costs. However, in the current market, this risk is muted by the unusually low rates locked in by many borrowers—most Fannie Mae mortgages are well below current rates, creating a significant cushion against refinancing.
Additionally, the technical backdrop for MBS has improved, with banks slowing their divestment from the sector. This has helped agency MBS outperform investment grade credit in recent months. With rates continuing to fall and refinancing risks low, agency MBS offers investors a more stable and defensive option, especially as demand for interest-rate-sensitive assets grows in response to the Fed’s rate cuts.
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Municipals
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Emerging market debt
Emerging market (EM) economies remain well-positioned to navigate a developed market (DM) slowdown, with growth expected near 4% for 2024. Growth differentials between EM and DM are anticipated to improve in 2025, despite headwinds from a slowing China and broader DM weakness. Inflation should moderate across most EM regions, though Latin America and EMEA may see persistent inflation due to strong domestic demand and currency depreciation. China’s recent stimulus measures may support its equity market but are unlikely to reverse its structural slowdown.
Elevated DM interest rates have weighed on EM debt, contributing to significant outflows. However, the Fed’s policy pivot should reverse these flows starting in late 2024, with demand expected to pick up in 2025. Lower bond issuance and negative net issuance have mitigated the impact of outflows, and while supply may increase, it should remain manageable.
EM debt spreads are tight relative to history, with spreads likely to remain rangebound for the remainder of 2024, with volatility expected around the U.S. election. Although EM credit is less correlated to growth than EM currencies and equities, growth differentials will remain a key driver of investment flows into EM debt as we move into 2025.
View next:
Private credit
The private credit market has seen a notable uptick in deal activity, fueled by expectations of Federal Reserve rate cuts and improving economic stability. This trend is expected to continue through the remainder of 2024 and into 2025, with private direct lending playing an increasingly prominent role in financing M&A and leveraged buyout (LBO) transactions. As commercial banks and the public loan market become less attractive options for private equity sponsors, the middle market private credit space stands to gain momentum.
Credit conditions have eased, leading to tighter spreads across various segments of the private credit market. While large-cap private credit and public market spreads have tightened considerably over the past year, the lower and core middle market segments have also seen spread tightening, improving by approximately 75 basis points from 2023 highs. These tighter spreads, along with lower leverage levels, minimal payment-in-kind (PIK) features, and strong maintenance covenants, enhance the relative value of lower and core middle market lending opportunities for investors.
Despite a competitive environment in larger segments of the market, the lower and core middle market continues to offer attractive value. With more resilient industries and first lien senior secured lending structures, middle market direct lending offers attractive risk premiums. Whether the Fed's rate path is measured or accelerated in response to economic volatility, private credit provides diversification and resilience, positioning it as a key area of opportunity for investors.
View last:
Emerging market debt
U.S. outlook
The Federal Reserve’s stance has evolved significantly since 2023. At the Jackson Hole Symposium last year, Chair Jerome Powell highlighted the ongoing challenges with inflation and labor market rebalancing. However, by 2024, the tone has shifted, with inflation nearing the Fed’s 2% target and a renewed focus on preventing labor market cooling. In response, the Fed began cutting rates in September with a 50 bps reduction, marking the start of its rate-cut cycle. Further rate cuts will hinge on labor market trends. If unemployment continues to rise and payrolls decline, the Fed may adopt a more aggressive stance, potentially pushing the Fed funds rate lower than the anticipated 3.25% by mid-2025.
A soft landing remains the base case, and much of the Fed’s easing is already reflected in market pricing. Yield curve steepeners, especially at the front end, offer strong opportunities, though outright duration positions are less attractive for now. Fixed income spreads are tight relative to historical norms, but they are supported by strong corporate profit margins. While risks such as geopolitical events and election volatility loom, healthy profit margins and limited recession risks provide a stable outlook for spreads in the near term.
Download full report (PDF)
Market environment
Year-to-date performance, spread, and yield for various fixed income indices
Data as of September 30 2024. Source: Bloomberg, Principal Fixed Income. 1Total returns for representative indices. 2Spread to Treasury. Min, max, and average based on last 10 years. 3Index yield to worst. Min, max, and average based on last 10 years. Weighted average yield-to-maturity reflected for U.S. Bank Loans. Indices are unmanaged and do not take into account fees, expenses, and transaction costs, and it is not possible to invest in an index.
Indices used in order of appearance: Bloomberg U.S. Aggregate Index, S&P/LSTA (Loan Syndications and Trading Association) Leveraged Loan 100 Index, Bloomberg U.S. Corp HY 2% Issuer Capped Index, J.P. Morgan EMBI Global Diversified Index, Bloomberg Asset-Backed Securities Index, Bloomberg CMBS ERISA-Eligible Index, Bloomberg U.S. Municipal Bond Index, Bloomberg U.S. Credit Index, Bloomberg U.S. Treasury Index, Bloomberg U.S. MBS Index
Investment grade credit
02
03
04
05
06
Investment
grade credit
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
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Principal Fixed Income
Fixed income perspectives
Themes, outlook, and investment implications across
global fixed income markets
4Q 2024
Featured insights
Download full report (PDF)
Read more
Municipal bonds have remained attractive to investors throughout 2024, and the Fed’s easing cycle presents a unique opportunity to extend duration. While fundamentals in the municipal market are strong, with upgrades outpacing downgrades, technical factors have been a challenge.
Municipal supply has surged, driven in part by election-related uncertainty, creating headwinds for the asset class. However, as supply moderates in the fourth quarter, we expect municipal bonds to present a compelling opportunity for investors seeking tax-advantaged income. Historically, municipals have outperformed T-bills after the Fed begins cutting rates, driven in part by election-related uncertainty, municipal supply has surged, creating headwinds for the asset class.
The current environment, with an elevated risk of recession but a base case for a soft landing, is particularly attractive for muni investors. With yields at some of the widest levels of 2024, now may be an opportune time to lock in attractive, tax-advantaged income before the market prices in further Fed rate cuts.
Year-to-date performance, spread, and yield for various fixed income indices
J.P. Morgan U.S. Liquid Investment Grade Corporate Index, 2015–present
>=AA-
A+
A
A-
BBB+
BBB
BBB-
11%
12%
12%
11%
12%
13%
13%
12%
11%
10%
15%
16%
16%
20%
21%
19%
20%
20%
20%
19%
19%
18%
19%
19%
17%
18%
18%
17%
16%
17%
17%
19%
19%
16%
16%
16%
16%
16%
17%
18%
17%
12%
14%
14%
17%
18%
18%
14%
15%
14%
11%
9%
9%
8%
8%
6%
7%
12%
13%
13%
11%
14%
11%
11%
10%
9%
9%
9%
9%
9%
46%
51%
44%
Performance (YTD, %)
1
Spread (bps)
2
Yield to Worst (%)
3
U.S. Aggregate
U.S. Bank Loans
U.S. HY Credit
Emerging Market Debt
U.S. ABS
U.S. CMBS
U.S. Municipals
U.S. IG Credit
U.S. Treasury
U.S. MBS
MIN
AVG
MAX
4.45
8.17
8.00
6.25
6.07
5.32
5.07
4.50
3.84
2.30
211
263
54
80
22
7
-156
720
1100
260
373
325
132
250
247
93
89
64
42
-90
321
418
92
122
55
36
-11
1.0
3.5
3.5
1.3
3.6
1.7
0.4
0.9
0.4
0.9
2.8
5.5
6.5
3.1
6.1
3.6
2.4
3.0
2.2
2.4
7.0
4.6
8.9
4.7
4.4
4.5
3.3
MIN
AVG
MAX
5.7
8.7
11.7
6.5
13.1
6.4
6.0
6.0
5.1
4.5
3.8
6.3
4.2
-5%
-3%
-1%
-0%
1%
3%
5%
Emerg.Market Debt
U.S. HY Credit
U.S. CMBS
U.S. Bank Loans
U.S. IG Credit
U.S. ABS
U.S. MBS
U.S. Treasury
U.S. Municipals
262
295
Click key to isolate
Data as of September 30 2024. Source: Bloomberg, Principal Fixed Income. 1 Total returns for representative indices. 2 Spread to Treasury. Min, max, and average based on last 10 years. 3 Index yield to worst. Min, max, and average based on last 10 years. Weighted average yield-to-maturity reflected for U.S. Bank Loans. Indices are unmanaged and do not take into account fees, expenses, and transaction costs, and it is not possible to invest in an index. Indices used in order of appearance: Bloomberg U.S. Aggregate Index, S&P/LSTA (Loan Syndications and Trading Association) Leveraged Loan 100 Index, Bloomberg U.S. Corp HY 2% Issuer Capped Index, J.P. Morgan EMBI Global Diversified Index, Bloomberg Asset-Backed Securities Index, Bloomberg CMBS ERISA-Eligible Index, Bloomberg U.S. Municipal Bond Index, Bloomberg U.S. Credit Index, Bloomberg U.S. Treasury Index, Bloomberg U.S. MBS Index
Market environment
Year-to-date performance, spread, and yield for various fixed income indices
Performance (YTD, %)
1
Spread (bps)
2
Yield to Worst (%)
3
U.S. Aggregate
Emerging Market Debt
U.S. HY Credit
U.S. CMBS
U.S. Bank Loans
U.S. IG Credit
U.S. ABS
U.S. MBS
U.S. Treasury
U.S. Municipals
4.45
8.17
8.00
6.25
6.07
5.32
5.07
4.50
3.84
2.30
-5%
-3%
-1%
-0%
1%
3%
5%
211
263
54
80
22
7
-156
720
1100
260
373
325
132
250
321
418
92
122
55
36
-11
247
295
93
89
64
42
-90
MIN
AVG
MAX
1.0
3.5
3.5
1.3
3.6
1.7
0.4
0.9
0.4
0.9
5.7
8.7
11.7
6.5
13.1
6.4
6.0
6.0
5.1
4.5
2.8
5.5
6.5
3.1
6.1
3.6
2.4
3.0
2.2
2.4
4.2
6.3
7.0
4.6
8.9
4.7
4.4
4.5
3.8
3.3
MIN
AVG
MAX
= Current Value