Bond markets generally positive as Fed extends pause
Investors wait as the Fed pushes expectations for rate cuts
David Bradin
Investment director
Catherine Magyera
Investment product manager
Key takeaways for the quarter ended June 30, 2024
- In the second quarter, fixed income markets were generally positive despite higher yields as the Fed pushed back its expectations for rate cuts. Below-investment-grade (BB/Ba and below) debt was a notable exception, with both high-yield corporate bonds and municipals delivering the strongest results for the quarter.
- Over longer term periods, the majority of fixed income American Funds (Class F-2) continued to deliver positive absolute returns and positive relative returns compared to their primary benchmarks.
- We believe important portfolio roles for fixed income funds include income, inflation protection, capital preservation and diversification from equities. Capital Group offers investments that balance these roles across fixed income mutual funds and exchange-traded funds (ETFs).*
Fixed income market results were generally positive in the second quarter despite slightly higher yields and modestly widening spreads in multiple sectors. U.S Treasury yields peaked in April, then drifted lower to ultimately end modestly higher at quarter-end than at the end of March. The yield curve ended the quarter inverted (where short-term interest rates are higher than long-term rates), although less inverted than at the end of March. Corporate credit spreads widened slightly across both high-yield and investment-grade bonds (BBB/Baa and above), and shorter duration bonds generally outperformed their longer duration counterparts. Duration indicates a bond fund’s sensitivity to interest rates; generally, lower duration indicates less sensitivity. The Bloomberg U.S. Aggregate Index returned 0.07% for the quarter.
Amidst mixed economic data, the Federal Open Market Committee (FOMC) kept rates on hold, continuing to emphasize data dependency on their path to lower inflation towards an average level of 2%. The U.S. Federal Reserve (Fed) pared back its forecast for interest rate cuts in 2024 in its May meeting, from 75 basis points (bps) to 25 bps. The Fed also communicated it needs more confidence that inflation is decelerating further before loosening policy.
Inflation data has trended lower after stronger reports earlier this year. Further deceleration will likely be driven by “stickier” components of the Consumer Price Index (CPI) and a softening in the labor market. For example, rent and owners’ equivalent rent (OER) were responsible for most of the move higher in inflation since 2021, but have been in a disinflationary trend over the last 12 months. Within core goods, used vehicle prices, also a significant contributor to inflation from 2021-2022, are helping to lower inflation.
Softening inflation paves the way for the Fed to begin cutting interest rates. However, the timing and extent of the cuts remains uncertain. The 2-year, 5-year, 10-year and 30-year Treasury yields increased 13 bps, 16 bps, 20 bps and 22 bps, respectively. The 10-year Treasury yield ended the quarter at 4.40% and the two-year Treasury yield ended the quarter at 4.76%. Credit spreads across high-yield and investment-grade markets modestly widened this quarter. Investment-grade credit spreads ended the quarter at 94 bps over Treasuries, wider by 4 bps compared to the previous quarter-end. High-yield credit spreads ended the quarter at 309 bps over Treasuries, wider by 10 bps from March 31, 2024. The yield to worst on the Bloomberg U.S. Corporate High Yield Index was 7.91% as of the end of June.
Sources: Bloomberg Index Services Ltd., RIMES. As of 6/30/24. Past results are not predictive of results in future periods.
Source: Bloomberg Index Services Ltd. As of 6/30/24. Past results are not predictive of results in future periods.
U.S. fixed income markets generally positive in the second quarter despite higher yields quarter over quarter
U.S. bond market returns were generally positive for the quarter. Taxable and tax-exempt high yield securities delivered the strongest results. The Bloomberg U.S. Aggregate Index, which represents the broad bond market, returned 0.07%. Shorter duration assets generally outpaced their longer duration counterparts amidst a modestly rising yield environment.
Amidst this, 21 of our 24 fixed income mutual funds and ETFs had positive absolute results for the quarter. In terms of benchmark relative results, 22 of our 24 fixed income mutual funds and ETFs delivered results in line (within 10 bps) or ahead of their primary benchmarks. Generally, funds with shorter duration benefited as yields rose. Despite credit spreads widening slightly quarter over quarter, exposure to corporate credit was also generally additive.
Anchoring your portfolio with disciplined fixed income mutual funds and ETFs
Given the potential for decelerating, but still historically elevated, inflation and a more favorable macroeconomic outlook, we believe a disciplined approach to overall portfolio construction will remain critical. As a result, we look to construct portfolios that reflect balanced risks across excess return drivers and diverse macroeconomic outcomes. Broadly, fixed income seeks to provide income, preserve capital, diversify from equity risk and pursue inflation protection — all of which can be vital for investor portfolios as the market remains uncertain.
Funds like American Funds Strategic Bond Fund for a core plus allocation, The Bond Fund of America® and The Tax-Exempt Bond Fund of America® for a core allocation, and American Funds Multi-Sector Income Fund to pursue diversified income, are all building blocks that can help investors seek prudent portfolio construction and pursue these investment goals.
The Bond Fund of America (ABNFX, Class F-2), our flagship core mutual fund, takes a gradual, balanced approach to core investing. Fund managers use a disciplined, value-based approach to sector positioning, striving for strong security selection in corporate bonds, mortgage-backed securities (MBS) and U.S. Treasury notes. The fund outpaced its benchmark, the Bloomberg U.S. Aggregate Index, over the 3-, 5- and 10-year periods (by 22 bps, 77 bps and 36 bps, respectively).
American Funds Strategic Bond Fund (ANBFX, Class F-2) uses a differentiated, disciplined approach that focuses primarily on duration, yield curve and inflation positioning, with a lesser, more opportunistic focus on credit sectors. The fund can help anchor a bond allocation, while aiming to maintain lower correlation with equities. It has delivered positive excess returns versus the benchmark, the Bloomberg U.S. Aggregate Index, over a long-term five-year period (102 bps).
The Capital Group Core Plus Income ETF (CGCP) can help anchor a portfolio while pursuing a consistent income. CGCP (market price) outpaced its primary index, the Bloomberg U.S. Aggregate Index, by 21 bps for the quarter. The ETF leverages multiple sources of active return potential, balancing preserving capital and pursuing income while also seeking total return. It invests across a diversified set of income sectors, including investment-grade and high-yield credit, securitized credit and emerging markets (EM) debt, aimed at generating a resilient income stream.
The Tax-Exempt Bond Fund of America (TEAFX, Class F-2), our most diversified municipal bond mutual fund, exceeded its benchmark, the Bloomberg Municipal Bond Index, over the 1-year (134 bps), 3-year (27 bps), 5-year (23 bps) and 10-year (14 bps) periods. The fund focuses on investment-grade securities with the flexibility to own higher income securities across the rating spectrum. TEAFX takes a risk-aware approach and seeks to add value through selectivity of both credit and interest rate exposures.
The Capital Group Municipal Income ETF (CGMU) is a single solution core municipal bond allocation that incorporates high-yield municipal bonds in its pursuit of resilient income. CGMU (market price) outpaced its primary index, the 85%/15% Bloomberg 1–15 Year Blend (1–17 Year) Municipal Bond Index/Bloomberg 1–15 Year Blend (1–17 Year) High Yield Municipal Bond Index, by 31 bps for the quarter. The ETF seeks to provide investors a tax-exempt income stream, capital preservation and total return.
American Funds Multi-Sector Income Fund (MIAYX, Class F-2) outpaced its blended benchmark over the 3-year (115 bps) and 5-year (139 bps) periods, highlighting the advantage of its distinctive approach. The fund is designed to pursue opportunities diversified across multiple fixed income sectors and seeks to provide high income.
The Capital Group U.S. Multi-Sector Income ETF (CGMS) is an option for investors seeking a higher income bond allocation. CGMS (market price) outpaced its primary index, the Bloomberg U.S. Aggregate Index, by 95 bps for the quarter. This U.S.-focused ETF leverages Capital Group’s research capabilities across a range of income sectors, both investment-grade and non-investment-grade (BB/Ba and below), while managing credit risk and volatility.
Market outlook
Looking ahead, some portfolio themes include:
- Interest rates: Positioning for a steeper yield curve remains a high conviction view given valuations. We also favor modestly adding to duration in portfolios when yields are at the higher end of their near-term ranges. A variety of scenarios may benefit the steepening bias. For example, once the Fed is actively cutting or if the economy enters recession. Alternatively, it may also benefit should the long end of the curve rise more (or fall less) than the front end due to Treasury supply or federal deficit concerns. Importantly, a steepening bias can complement risk exposures elsewhere, including Agency MBS and credit.
- Mortgage-backed securities. Active security selection within agency MBS offers compelling opportunities. In the near term, interest rates may remain somewhat range bound as the Fed’s patient stance sets a floor for how far rates can fall while its bias in favor of cutting rates serves as a ceiling of sorts. In this environment, the income and carry (interest income) potential of parts of the mortgage market (such as higher coupons) look appealing, particularly with nominal spreads (the spread between Treasury and non-Treasury securities of the same maturity) that may exceed those of corporate bonds. This part of the market also has generally lower sensitivity to both interest rates and mortgage spreads than the lower coupons more prevalent in the Bloomberg U.S. MBS Index.
- Modest and diversified exposure to select credit sectors should benefit from a benign macro environment. This exposure represents a view toward diversifying sources of carry across a variety of credit sectors. This is largely based on the potential to benefit from attractive levels of yield, rather than an expectation of tightening spreads. Investment grade corporates remain attractive relative to high yield, though idiosyncratic opportunities remain in both sectors. Many portfolios are also finding value in senior portions of securitized credit.
Fixed income remains a component for investors that seek balanced portfolios. We believe there are multiple areas of opportunity while waiting on the Fed. We believe fixed income can continue to serve the four roles of income, inflation protection, capital preservation and diversification from equities.
* This commentary excludes the American Funds Portfolio Series and American Funds Insurance Series® fixed-income mutual funds.
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