Insight

Monthly fixed income update - June 2023

Monthly fixed income update

Asset Class Returns

The employment report early in the month showed strong job gains in the US which set the tone for a month in which central banks appeared to sound increasingly hawkish around the need for further policy tightening to bring inflation down. While the Federal Reserve left rates unchanged for the first time this cycle, the European Central Bank hiked rates by 25bp and the Bank of England increased their pace of tightening with a 50bp hike due to inflation remaining elevated and wage growth accelerating. However, while they took different decisions in June, all three central banks indicated that further monetary policy tightening would be needed to bring inflation down. Nevertheless, June was broadly a positive month for riskier assets with equity markets generally performing well and lower rated bonds outperforming higher quality fixed income, while UK inflation also had a strong month.

Asset class returns
asset class returns

Source: Bloomberg, Invesco as at 30 Jun 2023

Government and Inflation-Linked Bonds

Yields on 10-year benchmark government bonds rose in the major economies in June. However, central bank rhetoric, which indicated that further rate hikes should be expected during the second half of the year, had a bigger impact on the shape of government bond yield curves. The yield spread between 2-year and 10-year government bonds hit multi-decade lows in the US, eurozone and the UK as short yields sold off in anticipation of higher rates. Inflation linked bonds in the different regions had different fortunes over the month as breakeven inflation rates were slightly narrower in the eurozone, slightly wider in the US, and considerably wider in the UK as inflation remained stubbornly high.

US Rates

US economic data provided a mixed picture in June. While the employment report showed strong job gains, it did also see the unemployment rate increase slightly. Survey data broadly showed signs that economic activity is slowing, and headline inflation fell slightly more than expected to 4.0%, although the core measure was above expectations. This allowed the Federal Reserve to hold rates for the first time since the start of the rate hiking cycle, although they signalled that the pause should not be seen as the peak in rates as it was accompanied by a forecast for higher rates at year end; along with Chairman Powell indicating that two or more further rate hikes may be needed to cool inflation. While the yield on 10-year US Treasuries rose by 19bp over the month, the bigger impact was on short-dated bonds with 2-year yields rising by 49bp and driving the yield spread between 2-year and 10-year Treasuries to go back to the lows seen in March.

US rates
us rates

Source: Bloomberg, Invesco as at 30 Jun 2023

Eurozone Rates

The ECB hiked rates by 25bp in the middle of June, taking rates to 4%. Although Q1 GDP was revised down, inflation remains well above the target and the ECB continued to sound hawkish which drove up rate expectations. This caused 10-year Bond yields to rise by 11bp over the month and the German yield curve to flatten, with the spread between 2-year and 10-year bonds reaching the most inverted levels for over 30 years. 

Eurozone rates
Eurozone rates

Source: Bloomberg, Invesco as at 30 Jun 2023

UK Rates

Earnings data released early in the month showed signs that UK inflation is starting to have second round effects as it feeds through to wages and pay demands. This was followed by inflation data showing the annual rate was unchanged at 8.7%, having been expected to fall, while core inflation ticked up to 7.1%, the highest level since the early 1990s. This caused the Bank of England to surprise the market with a 50bp hike, rather than the anticipated 25bp which, along with hawkish comments drove rate expectations higher. This pushed the 10-year gilt yield up by 21bp over the month and caused the curve to invert more aggressively than was seen in Treasuries and Bunds. But it was the strength of the inflation data that helped to drive breakeven inflation rates wider and for index-linked gilts to outperform their conventional counterparts.

UK rates
UK rates

Source: Bloomberg, Invesco as at 30 Jun 2023

Keep an eye on…

...any signs of economic weakness could add interest rate risk, as it feels like central banks are currently at peak hawkishness 

Investment Grade Credit

Central bank policy impacted credit spreads in different currencies during June. USD spreads tightened aggressively as the Federal Reserve left rates unchanged while EUR spreads ended the month slightly tighter following the expected 25bp hike from the ECB. However, concerns that the Bank of England will need to continue tightening until the economy slows to bring down inflation, along with some idiosyncratic fears around the amount of inflation-linked debt issued by some companies, meant that any gains early in the month were given back and GBP spreads ended the month unchanged.

Investment Grade Credit
Investment Grade Credit

Source: Bloomberg, Invesco as at 30 Jun 2023

Keep an eye on…

…relative value between different currencies with USD credit looking rich

High Yield and Subordinated Credit

The risk on tone was broadly positive for lower rated credit in June. Spreads on USD (-69bp) and EUR (-42bp) high yield tightened aggressively over the month. Hybrid securities lagged the strength of the more traditional fixed income but still performed well. Euro corporate hybrid spreads ended the month 15bp tighter while, for USD AT1s, spreads were 26bp tighter. The relative stability exhibited by AT1s in the second quarter, with three consecutive months of positive performance, has signalled that the impact of the Credit Suisse write down in March appears to have been fairly well contained. A further positive for the AT1 market came as the new issue market reopened for EUR denominated bonds with strong demand for issues from the Bank of Cyprus and BBVA.

High Yield and Subordinated Credit
High Yield and Subordinated Credit

Source: Bloomberg, Invesco as at 30 Jun 2023

Keep an eye on…

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

Fixed Income ETF Flows

Fixed income ETFs had a strong month with net inflows of $7.2Bn, taking year-to-date NNA to $32.7Bn. EUR IG, which has been the strongest category this year, led once again with a further $1.4bn NNA, taking net inflows so far this year above $10bn. The bias for higher quality remained with EUR Govts and US Treasuries taking second and third spot with $1.3bn and $1.2bn NNA respectively. Aggregate bond ETFs continued to see steady demand with net inflows of $710m. Having been out of favour for most of this year, FRNs experienced NNA of $671m, mainly due to investment in a single EUR FRN ETF. Demand for Gilts ($655m), particularly those focused on under five-year maturities, picked up following the rise in yields after the 50bp hike from the Bank of England. Outflows were light and were led by convertible bonds which was mainly driven by selling of AT1s following the steady recovery post Credit Suisse.

Top and Bottom 5 Fixed Income ETF Categories in June 2023
Top and Bottom 5 Fixed Income ETF Categories in April 2023

Source: Bloomberg, Invesco, as at 30 Jun 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.

Important information

  • This is marketing material and not financial advice. It is not intended as a recommendation to buy or sell 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 30 June 2023, unless otherwise stated

    Views and opinions are based on current market conditions and are subject to change

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