Investment grade outlook: Insights for November

October was another positive month for fixed income. The Bloomberg US Corporate Bond Index rose about 38 basis points (bps), which put it up 7.29% year to date.¹ The Bloomberg US Aggregate Bond Index rose 62 bps, up 6.80% year to date.² But the Federal Reserve (Fed) interest rate cut led to a selloff. What does it mean for investment grade bonds and the economy? We answer this and more in our Q&A on how we’re navigating the bond market in November.

Craig: October was a positive month, but it might have been an even better month if bonds hadn’t sold off by roughly 75 bps-1% after the Fed cut rates at the end of the month. What was driving the roughly 1.5% total returns before the Fed meeting?

Matt: Credit spreads were basically unchanged month-to-date in October, up until the Fed meeting. Spreads have already been tight, but that has been justified by solid fundamentals and good liquidity — both of which remain intact. Rates were already lower by about 12–20 bps across the yield curve, driven by expectations of multiple Fed cuts and some concern about softer economic momentum. But the real driver of total return continues to be positive carry. With starting yields in the 4.5–5% range, your baseline return from carry is about 40 bps per month.

Craig: The Fed cut rates by 25 bps, which was exactly what the market was pricing. Yet rates and stocks sold off and spreads widened. So clearly, investors didn’t love what they heard. What do you think spooked markets?

Matt: The Fed-issued Federal Open Market Committee (FOMC) statement noted that inflation had moved up since earlier in the year and remained elevated. It emphasized uncertainty around the economic outlook and downside risks to employment. But the key line was Chairman Jerome Powell saying December is not a foregone conclusion for another cut. So even though we got a cut — and quantitative tightening (QT) ends in December — the meeting was still interpreted as hawkish. Markets are now pricing fewer cuts next year.

Craig: There’s significant disagreement among Fed officials on the path of rates and the economy. We’ve also heard mirror views from financial professionals and clients. One financial professional called this the “owl market” because everyone’s looking in all directions, waiting for something to go wrong. But nothing has yet. Can you explain your views and how you’re positioned?

Matt: We think the economy is still fundamentally solid. Consumers have slowed a bit but remain healthy, corporate balance sheets look good, and we’re not seeing the kinds of excesses you’d expect before a downturn. So our base case isn’t a recession, it’s a moderation. But even in that environment, policy rates don’t need to stay this restrictive. We think the Fed is already effectively in restrictive territory. As inflation gradually drifts lower, it has room to bring the policy rate down toward something closer to neutral, which is around 3%. So we expect a world where growth is OK but rates migrate lower. That means we’re running a bit longer with bonds at the front-end of duration and the yield curve than we had earlier in the year, and continue to lean into high-quality spread sectors where fundamentals remain strong.

Craig: Whether we get a slowdown or the economy continues to do well, we believe both scenarios are positive for bonds. Investors must agree based on the significant flows into the asset class.³ But much of that has been going into passive, even though active managers historically have regularly added value in fixed income.⁴

Emily: More than 20 years of rolling three-year periods of data shows that at pretty much any fee load, there has been an advantage to being in active fixed income for a core plus mandate.⁵ A core plus fund holds a core of investment grade securities and adds a layer of higher-yielding bonds to potentially increase returns. Plus, with the upcoming 2026 market duration mandate, a US Treasury clearing regulation requiring a large portion of US Treasury cash and repurchase agreement (repo) market transactions to be cleared through an SEC-approved central clearing agency, it’s potentially challenging for long-term investors to make a case for fixed income outside of active.