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Monthly fixed income update - July 2023

Invesco monthly gold update

Asset Class Returns

July saw mixed fortunes for bond markets. The minutes of the June Federal Reserve meeting, which showed that some members had favoured a hike rather than the pause, along with strong ADP US employment data, set the tone for bond markets early in the month. Government bond yields sold off with the benchmark 10-year US Treasury rising above 4% for the first time since March. But markets direction soon changed, particularly following the release of US inflation data, which was lower than expected, before selling off once more into month-end following stronger-than-expected US GDP data. However, while economic data caused returns on government bonds to be close to flat for the month, credit markets performed well with lower-rated bonds leading as equities performed well in a generally positive environment for riskier assets, with AT1s being the star fixed income performer in July.

Asset class returns
asset class returns

Source: Bloomberg, Invesco as at 31 July 2023

Government and Inflation-Linked Bonds

While yields on US Treasuries and European government bonds lacked direction over the month, they ended the month slightly higher, which led to mildly negative returns. Meanwhile, following the 10-year Gilt hitting 15-year highs early in the month, the UK government bond market experienced a relief rally following both US and UK inflation data prints coming out lower than markets had anticipated. The weaker inflation data also had an impact on the UK index-linked Gilt market, which performed poorly as breakeven inflation rates narrowed over the month.
 

US Rates

US Treasuries were rangebound during July, initially selling off in response to the June Federal Reserve meeting minutes, which showed some members favoured a hike in June rather than a pause, signalling that a further hike in July was likely. This was reinforced by the strong ADP employment data, although it was not backed up by the employment report, which came out broadly in line with market expectations. Treasury yields then rallied as both headline and core inflation printed lower than expected; at 3.0%, headline CPI is now at the lowest level since March 2021. The Federal Reserve delivered the expected 25bp hike later in the month, taking rates to 5.5%, the highest level for 22 years. Although the rate decision had little impact on the market, the stronger-than-expected GDP data drove US Treasury yields higher into month-end. While TIPS yields tracked Treasuries in the first half of the month, breakeven inflation rates widened towards month-end following strong demand for the 10-year TIPS auction, which led to TIPS outperforming Treasuries over the month even with the lower inflation print.

US rates
us rates

Source: Bloomberg, Invesco as at 31 July 2023

Eurozone Rates

Although inflation continued to fall in the eurozone, at 5.5% it remains well above target and led the ECB delivering the expected 25bp hike towards the end of July, taking rates to 4.25%. With few economic surprises over the month, core eurozone markets took their lead from US Treasuries with yields remaining rangebound while peripheral markets benefited from the broad risk-on tone over the month.

Eurozone rates
Eurozone rates

Source: Bloomberg, Invesco as at 31 July 2023

UK Rates

10-year Gilt yields rose to 4.7% early in the month, a new 15-year high having surpassed levels around the time of the Truss/Kwarteng mini budget last September. However, signs that previous hikes are starting to impact the economy soon caused yields to rally. The unemployment rate ticked up and the housing market appears to be softening following the rise in mortgage rates, but it was the weaker-than-expected inflation data that drove the rally further. While headline CPI remains well above target at 7.9%, it was still 0.3% below market expectations. In addition to driving the Gilt rally in the second half of the month, the lower inflation print also led to breakeven inflation rates falling and index-linked Gilts underperforming.

UK rates
UK rates

Source: Bloomberg, Invesco as at 31 July 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 performed well in July as spreads tightened in the three major currencies. Although there didn’t appear to be a specific catalyst, the combination of inflation continuing to fall back towards target and interest rates closer to peaking has increased hope that central banks will be able to engineer a soft landing, which led to an increased appetite for risk during the month. While USD investment-grade spreads tightened by 10bp in July, they lagged the rally seen in EUR (-16bp) and GBP (-21bp) credit spreads. This is perhaps unsurprising given the starting point, with EUR and GBP credit spreads trading at wider levels to USD credit.

Investment Grade Credit spreads
Investment Grade Credit

Source: Bloomberg, Invesco as at 31 July 2023

Keep an eye on…

...relative value between different currencies with USD credit spreads looking rich relative to EUR and GBP

High Yield and Subordinated Credit

Lower-rated debt markets performed strongly in July, benefiting from the risk-on tone. Unlike investment-grade markets, however, it was USD-denominated debt that outperformed. While USD high yield spreads tightened by 24bp, the USD AT1 market was the star performer for the month with spreads tightening by 46bp, with the market receiving a boost into month-end as Barclays announced it would call its $2.5bn issue in September. Although spread tightening for EUR-denominated debt was less aggressive, both EUR high yield (-20bp) and Euro Corporate Hybrid (-10bp) spreads rallied during July. 

High Yield and Subordinated Credit
High Yield and Subordinated Credit

Source: Bloomberg, Invesco as at 31 July 2023

Keep an eye on…

...AT1 market performance, which is likely to drive risk appetite

Fixed Income ETF Flows

Fixed income ETFs had a very strong month with net inflows of $9.3Bn, taking year-to-date NNA to $45.3Bn. However, unlike in recent months, it is difficult to pick a theme with several categories seeing strong inflows. US Treasuries and Gilts were the strongest categories taking in $2.2bn and $1.5bn respectively. Cash Management ETFs came in third place with $1.0bn NNA, followed by EM Government bonds ($0.9bn), USD Investment Grade Credit ($0.9bn), and High Yield ($0.7bn). EUR Investment Grade Credit ($0.5bn) completes the categories that saw inflows over $0.5bn. Outflows were light with only Smart Beta (-$0.3bn) seeing material selling over the month. 

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

Source: Bloomberg, Invesco as at 31 July 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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