Better yield 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, especially in core components like housing and medical care. While we believe inflation will continue to decline, the pace of this deceleration will be slow and inflation will remain above trend for some time. The growth data is consistent with the notion of a recession, albeit shallow with a resilient labor market and service sector.

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  • The CPI does not tell the whole story. Headline inflation is showing signs of peaking, with prices for energy and other commodities falling in recent months. While this is fueling the overall CPI, core prices are less influenced by it and show more of a stagnant trend. Our basic view is that headline inflation will continue to moderate, but the core could remain bullish due to some lag effects in rents and labor markets.

Headline inflation relative to core CPI (Annual)
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 short term. With recent inflation figures, the Fed is expected to raise rates by 75 basis points at the September FOMC meeting. Forward pricing of the Secured Overnight Funding Rate (SOFR) tells us how the market is pricing the future federal funds rate. It is pricing an additional 175 basis points through the end of 2022 at a terminal rate of 4.25% for this up cycle, which may prove too aggressive.

3M SOFR Futures versus Fed Funds Rates
Source: Sage, Bloomberg

  • Beyond the short term for fixed income securities. Slowly moderating inflation and pockets of strength in the economy will likely prompt the Fed to raise rates quite aggressively through year-end and continue to put pressure on rates and securities yields short-term fixed income. A look a little further suggests that we are approaching a solid period for fixed income securities, which have generally rebounded from negative returns, posted strong returns after Fed cycles and weathered recessions well.

Bond Market Return Conditions (Global Bond Index)
Source: Sage, Bloomberg

*Assuming a return of -11% in 2022

  • All-in yield for IG fixed income – Highest in over a decade. Investment-grade corporate bonds are now trading at a yield above 5%, the highest in 15 years. Shorter dated sectors offer an attractive entry point, as the yield per unit of duration has risen sharply.

Yield (bps) per year of duration of short bonds compared to intermediate bonds
Source: Sage, Bloomberg

  • MBS spreads are close to the widest levels of the year. The national average rate for a 30-year mortgage is now above 6%, its highest level since 2007. Nominal MBS spreads, especially on higher coupons, remain very attractive, especially relative to credit companies.

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

Disclosures: This is for informational purposes only and is not intended to be investment advice or an offer or solicitation to buy or sell any security, strategy or product. of investment. Although statements of fact, information, charts, analysis and data contained in this report have been obtained from and are based on sources that Sage believes to be reliable, we do not warrant their accuracy, and the information, data, Underlying Public Figures and Information The information available has not been verified or audited for accuracy or completeness by Sage. Further, we do not represent that the information, data, analysis and graphics are accurate or complete and, as such, should not be relied upon as such. All results included in this report constitute the opinions of Sage 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 situation. All investments involve risk and may lose value. Past performance is not indicative of future results.

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