Fixed Income Monthly - October 2023
The Fixed Income Monthly provides a forward-looking summary of the medium-term views from the Fidelity Fixed Income team.
Yields continued to rise in September with US 10y Treasuries now edging over 4.8%, a rise of 70bps since the end of August. The bond market has been pushing out expectations of a Fed pivot since the banking crisis in March and increasing its estimate of the terminal rate. The market is now pricing the Fed to hold rates at 5.5% (with a roughly even chance of one final hike in November) until mid-2024. Thereafter, modest cuts of around 75bps are expected to the end of 2024. The pivot is still a long way off.
At the September FOMC meeting, the Fed raised its forecast for interest rates next year, emphasised its focus on a soft landing and reiterated its commitment to maintaining higher rates to bring inflation to target. The market has largely bought into the Fed’s higher for longer narrative and is demanding greater term premium.
Fiscal policy is also contributing to the rise in yields. Following the debt ceiling agreement in June, there has been a substantial rise in the US fiscal deficit. The deficit is running at around $1.5 trillion or 8.5% of GDP and is expected to be $1.6 trillion next year. That means public debt will continue to rise, having already breached $33 trillion or 123% of GDP in June. To plug the deficit, gross Treasury supply in 2024 will need to rise by around $700 billion (in 10y bond equivalents) to over $3 trillion. That’s a huge wave of government bond issuance for the market to soak up.
This combination of growing Treasury supply, rising interest rate term premium and the pricing of higher terminal rates are conspiring to push yields higher. But this is not a sustainable dynamic. High debt and high interest rates put a strain on the economy just as many corporates face a debt maturity wall where they are scheduled to roll over debt over the next few years. Global liquidity is declining, corporate leverage is rising and monthly US bankruptcies among small companies has leapt higher this year.
If these conditions continue, the stress in the economy could become so pronounced that despite the Fed’s commitment to higher rates, the economic reality of a hard landing could force it to reverse course, even if inflation remains above target.
Historically, the most profitable long-term point to invest in duration is when the Fed stops raising rates. With bond yields now exceeding the earnings yield on large cap US stocks, this could be a rare opportunity to lock in attractive yields and be exposed to recovering bond prices.
Global CIO Fixed Income
Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only.
Investors should note that the views expressed may no longer be current and may have already been acted upon.
The value of investments and the income from them can go down as well as up so you may get back less than you invest. Past performance is not a reliable indicator of future results.
Bond investments: The price of bonds is influenced by movements in interest rates, changes in the credit rating of bond issuers, and other factors such as inflation and market dynamics. In general, as interest rates rise the price of a bond will fall. The risk of default is based on the issuer's ability to make interest payments and to repay the loan at maturity. Default risk may, therefore, vary between different government issuers as well as between different corporate issuers.
Corporate bonds: Due to the greater possibility of default an investment in a corporate bond is generally less secure than an investment in government bonds.
High yield bonds: Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of the Fund investing in them.
Overseas Markets: Overseas investments will be affected by movements in currency exchange rates. The value of the investment can be affected by changes in currency exchange rates.
Currency Hedging: Currency hedging is used to substantially reduce the risk of losses from unfavourable exchange rate movements on holdings in currencies that differ from the dealing currency. Hedging also has the effect of limiting the potential for currency gains to be made.
Emerging Markets: Investing in emerging markets can be more volatile than other more developed markets.
Derivatives: Some fixed income investments may make use of derivatives and this may result in leverage. In such situations performance may rise or fall more than it would have done otherwise, and expose investors to the risk of financial loss if a counterparty used for derivative instruments subsequently defaults.
Hybrid securities: Hybrid securities typically combine both equity and debt sensitivities and exposures. Hybrid bonds are subordinated instruments that have equity like characteristics. Typically, they include long final maturity (or no limitation on maturity) and have a call schedule increasing reinvestment risk. Their subordination typically lies somewhere between equity and other subordinated debt. As such, as well as typical ‘bond’ risk factors, hybrid securities also convey such risks as the deferral of interest payments, equity market volatility and illiquidity. Contingent convertible securities (“CoCos”) are a form of hybrid debt security that are intended to either convert into equity or have their principal written down upon the occurrence of certain ‘triggers’ linked to regulatory capital thresholds or where the issuing banking institution’s regulatory authorities considers this to be necessary. CoCos will have unique equity conversion or principal write-down features which are tailored to the issuing banking institution and its regulatory requirements.
This information must not be reproduced or circulated without prior permission.
Fidelity only offers information on products and services and does not provide investment advice based on individual circumstances, other than when specifically stipulated by an appropriately authorised firm, in a formal communication with the client.
Fidelity International refers to the group of companies which form the global investment management organisation that provides information on products and services in designated jurisdictions outside of North America. This communication is not directed at, and must not be acted upon by persons inside the United States and is otherwise only directed at persons residing in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required.
Unless otherwise stated all products and services are provided by Fidelity International, and all views expressed are those of Fidelity International. Fidelity, Fidelity International, the Fidelity International logo and F symbol are registered trademarks of FIL Limited.
Europe: Issued by FIL Pensions Management (authorised and regulated by the Financial Conduct Authority in UK), FIL (Luxembourg) S.A. (authorised and supervised by the CSSF, Commission de Surveillance du Secteur Financier), FIL Gestion (authorised and supervised by the AMF (Autorité des Marchés Financiers) N°GP03-004, 21 Avenue Kléber, 75016 Paris) and FIL Investment Switzerland AG.
This is a marketing communication which is intended for professional clients only and not a suitable basis for the general public or private investors.
For German Wholesale clients issued by FIL Investment Services GmbH, Kastanienhöhe 1, 61476 Kronberg im Taunus.
For German Institutional clients issued by FIL (Luxembourg) S.A., 2a, rue Albert Borschette BP 2174 L-1021 Luxembourg.
For German Pension clients issued by FIL Finance Services GmbH, Kastanienhöhe 1, 61476 Kronberg im Taunus.
Investors/ potential investors can obtain information on their respective rights regarding complaints and litigation in English here: Complaints handling policy (fidelity.lu) and in German here: Beschwerdemanagement (fidelity.de).
The information above includes disclosure requirements of the fund’s management company according to Regulation (EU) 2019/1156.
Unless stated differently, information dated as of August 2023.