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Monthly fixed income update - August 2023

Invesco monthly gold update

Asset Class Returns

Although fixed income ETFs flows were typically low during August and, by month end, returns for most fixed income asset classes were close to flat, there was a fair amount of market movement during the month. Government bonds sold off into mid-August with the benchmark 10-year Treasury yield hitting a new cycle high of 4.36%, 40bps higher than at the end of July. But sentiment changed towards the end of the month as softer data signalled that previous rate hikes are having an impact on the economy which caused bond markets to rally.

While yields on European government bonds were little changed by month end, US Treasury yields ended the month higher than at the end of July and causing slightly negative returns for August. Credit spreads were also wider over the month, mainly due to concerns about the economic outlook. 

Asset class returns in August
asset class returns

Source: Bloomberg, Invesco as at 31 Aug 2023

Government and Inflation-Linked Bonds

For most of the last two years, government bond yields have primarily been driven higher by rate hikes and expectations of further tightening from central banks. This has also had an impact on the shape of yield curves as shorter-dated bond yields have risen by more than those on longer-dated bonds, which has caused government bond curves to invert between 2-year and 10-year maturities. While government bond markets sold off to the middle of August before rallying into month end, the main driver last month wasn’t higher rate expectations, but some unwinding of the curve inversion early in the month; followed by curves flattening once more (re-inverting) into month end.

US Rates

The August refunding announcement showed larger than expected increases in the auction sizes for US Treasuries across all maturities. In total, an additional $15bn of US Treasury supply needed to be sold during the month which, with concerns about future levels of issuance, put pressure on longer term yields, with the lower liquidity of the August holiday period potentially exaggerating the sell off. Economic data released earlier in the month did little to change rate expectations but, while the inflation data was broadly in line with forecasts, the psychological impact of the annual rate of headline inflation increasing from 3.0% to 3.2% (the first increase since the down trend started in the middle of last year) also put further pressure on longer term yields. But, following the 10-year Treasury yield hitting a new cycle high of 4.36% mid-month, the market rallied into month end. The change in sentiment appears to have mainly been driven by weaker economic data with some weakness seen in durable goods orders and both job openings and consumer confidence falling sharply towards the end of the month.

US rates
us rates

Source: Bloomberg, Invesco as at 31 Aug 2023

Eurozone Rates

Eurozone rates markets broadly took their lead from Treasuries during August with yields initially rising, driven by the spread between 2-year and 10-year bonds steepening before rallying once more into month end. Italian government bonds slightly underperformed German bonds over the month following first the announcement of a 40% windfall tax on Italian bank profits followed by a further announcement that it would be capped having seen the volatility the announcement had caused in Italian banks stocks.

Eurozone rates
Eurozone rates

Source: Bloomberg, Invesco as at 31 Aug 2023

UK Rates

Gilts followed a similar pattern to their US and eurozone counterparts. While Q2 GDP was revised higher, more timely economic data such as retail sales and house prices are showing some signs of weakness in the UK economy, which has stabilised rate expectations. Although consumer price inflation was slightly higher than expected, retail price inflation data (the reference for UK index-linked gilts) was in line with market forecasts. Nevertheless, breakeven inflation rates narrowed over the month as linkers failed to keep pace with gilts in the rally into month end, causing them to underperform.

UK rates
UK rates

Source: Bloomberg, Invesco as at 31 Aug 2023

Keep an eye on…

...signs of economic weakness to add interest rate risk with rates appearing close to the peak

Investment Grade Credit

Investment grade credit spreads were slightly wider in August, partly due to the low liquidity over the summer and partly due to concerns about the economic outlook. Having seen strong inflows so far this year, EUR-denominated credit ETFs saw material outflows over the month with GBP credit also experiencing some selling. However, the spread widening (USD +5bp, EUR +8bp, GBP +6bp) only partially unwound the tightening that was seen in July.

Investment Grade Credit spreads
Investment Grade Credit

Source: Bloomberg, Invesco as at 31 Aug 2023

Keep an eye on…

...ETF flows

High Yield and Subordinated Credit

Like investment grade, lower rated credit spreads also widened in August. US high yield held in best with spreads just 5bp wider and following a similar patter to USD investment grade with spreads widening as Treasury yields sold off and then tightening into month end as government bond yield rallied. However, spreads on USD AT1s (+22bp), EUR High yield (+15bp) and EUR corporate hybrids all experienced a more material widening over the month.  

High Yield and Subordinated Credit
High Yield and Subordinated Credit

Source: Bloomberg, Invesco as at 31 Aug 2023

Keep an eye on…

...the AT1 market as performance of anticipated new issues could indicate risk appetite 

Fixed Income ETF Flows

Fixed income ETFs had a quiet month with net inflows of $3.6bn, the lowest monthly NNA since February. Even so, net inflows into fixed income ETFs remain very strong for the year at $49.9bn. August flows indicated a risk off sentiment, with government bonds and cash management ETFs taking the top four places for the month. US Treasuries ($2.1bn) led, followed by EUR government bonds ($1.8bn) with Gilts ($0.5bn) in fourth spot. Cash management ETFs were sandwiched between EUR governments and Gilts in third place with $1.6bn NNA. In keeping with the risk off theme, outflows were seen from EM Government bonds (-$0.8bn) and High Yield (-$0.6bn). It’s worth noting that while EUR IG ETFs remain the strongest category for inflows so far this year ($10.3bn), they experienced heavy outflows (-$0.7bn) in August.

The risk off sentiment appears prudent given prevailing market levels and recent economic data. With a few specific exceptions, equity markets have performed well this year and, while investors still want to participate in the potential upside for risk assets, it’s worth hedging some of that risk with asset classes considered to be safe havens, such as developed market government bonds. With yields close to cycle highs and the rate hiking cycle close to the peak, high quality bond markets could provide healthy returns going forward, particularly if the economic landing isn’t as soft as central banks are hoping. 

Top and Bottom 5 Fixed Income ETF Categories in August 2023
Top and Bottom 5 Fixed Income ETF Categories in July 2023

Source: Bloomberg, Invesco as at 31 Aug 2023

Investment risks

  • The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

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