Monthly fixed income update - March 2023

Asset Class Returns
March was dominated by news about banks and the implications for both fixed income markets in the short term but also more broadly the potential impact on future central bank policy.
Following the collapse of Silicon Valley Bank (SVB) and Signature Bank earlier in the month, there were concerns about the impact on other mid-size US banks. In response, the Federal Reserve provided additional liquidity and US Treasury Secretary Yellen also stated necessary tools were available to prevent contagion.
Despite authorities’ efforts to calm the US market, banking concerns crossed the pond and started impacting Credit Suisse, which was already vulnerable whilst undergoing a restructuring process. This led to the hurriedly arranged takeover of Credit Suisse by UBS, with $17 billion of Credit Suisse AT1 bonds being written down in the process. Along with concerns about a banking crisis, this event had two main impacts on fixed income markets:
- The worst monthly performance for AT1s since the pandemic hit markets in March 2020
- A rally in high quality fixed income as expectations for further rate hikes were reduced as the aggressive tightening of monetary policy last year was linked to SVB’s demise.
Source: Bloomberg, Invesco as at 31 Mar 2023
Government and Inflation-Linked Bonds
Government and inflation-linked bond markets rallied in March as expectations for further rate hikes fell rapidly. SVB’s collapse had, in part, been caused by the fall in the value of its holdings in US Treasuries and mortgage-backed securities, which had been driven by aggressive rate hikes in 2022. Therefore, with concerns that SVB’s collapse could be the tip of a banking crisis iceberg, it appeared that central banks might be limited in their ability to hike rates further, as it could cause further problems in that sector.
US Rates
The yield on the benchmark 10-year US Treasury rallied by 45 basis points (bps) in March. However, the rally was led by short-dated US Treasuries as expectations for further rate hikes turned into expectations for rate cuts by year-end. The 2-year US Treasury yield ended the month 79bps lower, which meant the yield curve steepened sharply, having been flattening for the last two years. After hitting a new 40-year record level of inversion early in March, the yield curve between 2-year and 10-year US Treasuries steepened by over 50bps by the end of the month.
The US TIPS market also performed well considering the strength of the rally. Yield moves on inflation-linked bonds often lag their nominal counterparts in strongly directional markets; however, as it was concerns about the banking sector limiting the ability of the Federal Reserve to hike rates further and bring inflation under control, 10-year breakeven inflation rates only fell by 5bps in March with yields on 10-year TIPS rallying by 40bps.
Source: Bloomberg, Invesco as at 31 Mar 2023
Eurozone Rates
Like US Treasuries, eurozone government bonds rallied in March with yield curves steepening as expectations for further rate hikes were reduced. However, as the European Central Bank started hiking rates later than the Federal Reserve, and monetary policy tightening has been less aggressive so far, the market is still anticipating further rate hikes in coming months. The German 10-year yield rallied by 36bps, with core and peripheral markets both rallying by similar amounts. However, unlike the US, eurozone inflation-linked bonds couldn’t keep up in the rallying market, with breakeven inflation rates declining over the month.

Source: Bloomberg, Invesco as at 31 Mar 2023
UK Rates
The gilt market followed a similar pattern with 10-year yields rallying by 34bps over the month. However, while index-linked gilt yields tracked the conventional market for much of the month, they diverged towards month-end following the release of UK inflation data that surprised to the upside. This caused breakeven inflation rates to widen, with nominal yields rising and real yields falling towards the end of March and leading to particularly strong performance from the index-linked gilt market over the month.
Source: Bloomberg, Invesco as at 31 Mar 2023
...central bank policy and the outlook for inflation following problems in the banking sector
Investment Grade Credit
Concerns about the banking sector led to a widening of credit spreads over the month. In addition to the risk-off tone following the collapse of SVB, it was expectations that lending standards may need to be tightened, potentially choking economic growth, that were the primary causes. However, while the banking sector news was significant, actions by central banks and regulators calmed markets rapidly and credit spreads started tightening later in the month.
Source: Bloomberg, Invesco as at 31 Mar 2023
…banks and whether lending standards are tightened
High Yield and Subordinated Credit
While spreads widened across the board in reaction to bank failures and the write-down of Credit Suisse AT1s, it was relatively well contained and primarily focused on the AT1 market, which itself recovered into month-end. USD-denominated AT1 spreads ended the month 127bp wider than at the end of February. While that’s a huge move for a single month, considering the $17 billion write-down was by far the largest event the AT1 market has seen since its inception a decade ago, and that spreads were over 300bp wider at one stage, it did indicate that the market has matured and is relatively resilient to major news.
While USD- and EUR-denominated high yield spreads widened by 43bps and 61bps respectively, euro corporate hybrid spreads widened by only 35bps. Although their focus is on non-financial debt, the limited spread widening should be seen as a positive considering that, like AT1s for banks, hybrids are subordinated debt that rank below senior debt from the same issuer.
Source: Bloomberg, Invesco as at 31 Mar 2023
…AT1 market performance, which is likely to drive risk appetite
Fixed Income ETF Flows
With more than $6.2 billion of net new assets (NNA), March was a strong month for Fixed Income ETF inflows. It appears that concerns about a potential bank crisis broadly led to investors switching higher in quality, with Euro government bonds and US Treasuries accounting for almost 70% of NNA, with that figure approaching 90% if cash management is included in the “risk-off” trade. Outflows were relatively limited but led by the selling of floating rate note ETFs, possibly anticipating peak rates are near, with emerging market government bonds also seeing a reversal of fortunes as sentiment turned to “risk-off”.
Source: Bloomberg, Invesco, as at 31 Mar 2023.
What’s Next?
- Recent stimulus, and the race to “Net-Zero”(cutting greenhouse gas emissions to as close to zero as possible) spurring $8 Trillion a year of additional spending on materials globally is likely to have a material impact on inflation in the coming years. Baseline inflation forecasts assume flat commodity prices, in our view often underestimating future inflation given the green transitions’ likely impact on supply and demand dynamics. Specifically, the supply constraint in oil, gas and coal production before the supply of low carbon energy alternatives that are readily available are creating an energy supply constraint, whilst demand continues to grow. Thus, we believe that commodity price inflation will support a higher level of US CPI and that actual inflation will print much higher than break evens are pricing today.
- We expect real rates, defined as nominal Treasury Yields minus actual CPI, will continue to rise in a quantitative tightening world, and will spur bond investors to demand a positive real yield on intermediate and longer duration treasuries—that is, a positive real yield based on the factual inflation trend (rather than the inflation rate implied by the TIPS breakeven rate).
- For most of the past 15 years, 2 year TIPs(Treasury Inflation-Protected Securities) have meaningfully underpriced actual CPI trends.

- If the Federal Reserve hits the pause button on rate hikes this summer, we believe the market is underestimating the risk of a bear steepening if economic growth or inflation proves resilient in 2023. As such, we believe there may be a better time later this year to strategically add to intermediate, and eventually, longer duration, high quality credit.
How to position?
For cash management allocations, we remain constructive on short duration, high quality bonds such as US Treasuries and Munis. Given the rise in front-end interest rates this year, we believe the risk/reward skews in favor of US Treasury and Muni bonds with minimal duration to help capture potential higher yields and provide limited sensitivity to interest rate volatility.
Additionally, in lieu of traditional core bond funds, hold-to-maturity strategies like defined maturity ETFs can help mitigate interest rate volatility and provide investors with greater predictability on potential future portfolio returns. Laddering out a series of defined maturity ETFs can provide investors with a targeted portfolio duration and better visibility on potential total return relative to a traditional bond fund. We think that adding investment grade corporate bond ladders to portfolio can be another way to manage interest rate volatility in the current environment.
Short Duration Treasuries
- 3 month T-Bills started 2022 yielding roughly 0.09% and have increased 454bps to 4.63% as of the end of March 2023
- Very short duration US Treasuries can provide investors with a historically high yield to park cash in the near-term and potentially insulate from volatile interest rate movements
Muni Money Market Securities (VRDO’s)
- Variable Rate Demand Obligations (VRDO’s) are high quality floating rate muni securities that typically have coupons that reset weekly based on the SIFMA(Securities Industry and Financial Markets Association) Municipal Swap Index Yield
- The current yield on the SIFMA Swap Index is 3.97% as of 03/29/2023, or over 6.5% on a taxable equivalent yield for investors in the highest tax bracket
Investment Grade Corporate Bond Ladders
- Short to intermediate Investment Grade Corporate bond yields are at historically attractive levels(the highest since 2009) with yields still remaining near 4.5% across the curve
- Laddering Investment Grade Corporate bonds provides investors with balance across the curve, while providing continuous yearly liquidity for reinvestment in potential higher yielding bonds should US rates continue to increase
- By laddering bonds and holding them to maturity, investors can potentially mitigate interest rate risk and add greater visibility on future returns over a given time period
Short-Term TIPs
- Breakeven inflation rates may be underappreciating the possible inflation pressures in the near-term, as outlined in the graph.
- Short-term TIPs (up to 5 years maturity) may provide relative value to US Treasuries as a hedge should inflation overshoot expectations
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.
Important information
This document is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication.
Data as at 31 March 2023, unless otherwise stated
Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals, they are subject to change without notice and are not to be construed as investment advice.