Fixed income

Fixed income dashboard

July 30, 2024 - 3 min read

Portfolio Strategist – Natixis Investment Managers Solutions

At long last, the easing cycle is upon us. Central banks are in the business of risk management, balancing risks in a fashion to best achieves their mandate. For the US Federal Reserve (Fed), that mandate is two-sided: price stability and maximum employment. With inflation rapidly closing in on target and labor markets rebalanced and now providing a disinflationary impulse, the dual mandate appears back in balance.

Pressing for further or faster progress on one side of the mandate introduces greater risks of unintended and unnecessary consequences on the other side of the mandate. Disinflationary growth continues, but downside risks are growing at the margin, particularly within the labor market, where softening can follow nonlinear paths.

Interest rate cuts by the Fed are not about easing to spur growth, but rather to move policy back from restrictive territory to a more neutral setting. That said, September now appears to be a lock for that first Fed cut. But keep the rationale for cuts in mind when assessing market pricing of the path of policy over the next year, as we’ll likely see markets price in an overly dovish reaction function at some point in the quarters ahead. This is a policy recalibration, not an aggressive easing cycle.

Fed policy expectations

SOFR curve implied policy rate changes (as of 6/28/2024)

Source: Natixis Portfolio Analysis & Consulting; Bloomberg

The data continues to paint a picture of a soft landing with real growth remaining resilient while inflation continues to converge back to the Fed’s 2% target. Fundamentally that points to a healthy economy normalizing at about 4.5%–5.0% nominal growth, a backdrop that certainly remains supportive of corporate bond spreads remaining tight, particularly given the strength in corporate balance sheets and relatively light supply over the past few years.

And although spreads can remain tight for a prolonged period, with investment grade corporates trading close to the top decile in spreads going back to 1990, the risk-reward skew is asymmetric. There’s little incremental upside from further spreads compression when compared to the downside risk posed by spread widening should growth cool faster and further than expected.

Value in investment grade corporate bonds

Source: Bloomberg

In an environment where carry is the name of the game, there’s little incentive to dip aggressively into spread risk in the near term. That is particularly true given the attractive real and nominal yields provided by Treasuries. Although it may seem vanilla, a barbell approach with long Treasuries for ballast and short corporates, where spreads remain somewhat wider and incremental carry comes with little spread duration, appears to be one of the more compelling trades in fixed income at the moment.

This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Natixis Investment Managers or any of its affiliates. The views and opinions expressed are as of July 22, 2024, and may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted, and actual results may vary.

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